**Exhibit 99.2**

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MANAGEMENT’S REPORT TOTHE SHAREHOLDERS

The preparation of theaccompanying consolidated financial statements in accordance with accountingprinciples generally accepted in Canada with a reconciliation to generallyaccepted accounting principles in the United States is the responsibility ofmanagement.  Financial informationcontained elsewhere in this Annual Report is consistent with that in theconsolidated financial statements.

Management is responsiblefor the integrity and objectivity of the financial statements.  Where necessary, the financial statementsinclude estimates, which are based on management’s informed judgments.  Management has established systems ofinternal controls, which are designed to provide reasonable assurance that transactionsare authorized, assets are safeguarded and financial records are properlymaintained to provide reliable information for the preparation of financialinformation.

The Board of Directors isresponsible for ensuring that management fulfills its responsibilities forfinancial reporting and internal control. It exercises its responsibilities primarily through the Audit Committee,whose members are non-management directors. The Audit Committee has reviewed the consolidated financial statementswith management and the auditors and has reported to the Board of Directors whohave approved the consolidated financial statements.

MEYERSNORRIS PENNY LLP are independent auditors appointed by Canadian Superior EnergyInc.’s shareholders. The auditors have audited the consolidated financialstatements in accordance with Canadian generally accepted auditing standardsand the standards established by the Public Company Accounting and OversightBoard (PCAOB) to enable them to express an opinion on the fairness of thepresentation of the financial statements in accordance with Canadian generallyaccepted accounting principles.
| March 12, 2007 |   | Greg S. Noval                        |
|----------------|--------|--------------------------------------|
|           |   | Chairman and Chief Executive Officer |

 

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AUDITORS’ REPORT TO THESHAREHOLDERS

We have audited theconsolidated balance sheets of Canadian Superior Energy Inc. as at December 31,2006 and 2005 and the consolidated statements of operations and deficit andcash flows for the years then ended. These financial statements are the responsibility of the Corporation’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

We conducted our auditsin accordance with Canadian generally accepted auditing standards and thestandards of the Public Company Accounting Oversight Board (UnitedStates).  These standards require that weplan and perform an audit to obtain reasonable assurance whether the financialstatements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting theamounts and disclosures in the financial statements.  An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation.

In our opinion, theseconsolidated financial statements present fairly, in all material respects, thefinancial position of the Corporation as at December 31, 2006 and 2005 and theresults of its operations and its cash flows for the years then ended in accordancewith Canadian generally accepted accounting principles.

The financial statementsas at and for the year ended December 31, 2004 were audited by the otherauditors, who expressed an opinion without reservation on these statements intheir report dated March 31, 2005.
| CALGARY, CANADA |   | MEYERS NORRIS  PENNY LLP |
|-----------------|--------|--------------------------|
| March 12, 2007  |   | CHARTERED  ACCOUNTANTS   |
|            |   | Independent  Registered  |

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CONSOLIDATEDBALANCE SHEETS DECEMBER 31 

Thousands of dollars
| ** **                                       | ** ** | **2006**      | ** **    | **2005**      | ** **   |
|--------------------------------------------------|------------|---------------|---------------|---------------|--------------|
| ***Assets***                                     | * *   | * *      | * *      | * *      | * *     |
| *Current Assets*                                 | * *   | * *      | * *      | * *      | * *     |
| *Cash and short-term investments*                | * *   | ***$***       | ***7,338***   | *** ***  | ***$***      | ***11,798*** | *** *** |
| *Accounts receivable*                            | * *   | ***17,114***  | *** ***  | ***8,968***   | *** *** |
| *Prepaid expenses*                               | * *   | ***785***     | *** ***  | ***774***     | *** *** |
| * *                                         | * *   | ***25,237***  | *** ***  | ***21,540***  | *** *** |
| *Nova  Scotia offshore term deposits (Note 4)*   | * *   | ***14,805***  | *** ***  | ***14,421***  | *** *** |
| *Petroleum  and natural gas properties (Note 5)* | * *   | ***185,426*** | *** ***  | ***150,384*** | *** *** |
| * *                                         | * *   | ***$***       | ***225,468*** | *** ***  | ***$***      | ***186,345*** | *** *** |
| ***Liabilities***                                | * *   | *** ***  | *** ***  | *** ***  | *** *** |
| *Current  liabilities*                           | * *   | *** ***  | *** ***  | *** ***  | *** *** |
| *Accounts payable and accrued liabilities*       | * *   | ***$***       | ***17,997***  | *** ***  | ***$***      | ***15,754*** | *** *** |
| *Revolving production loan (Note 6)*             | * *   | ***7,910***   | *** ***  | ***12,851***  | *** *** |
| * *                                         | * *   | ***25,907***  | *** ***  | ***28,605***  | *** *** |
| *Convertible  preferred shares (Note 9)*         | * *   | ***15,472***  | *** ***  | ***—***  | *** *** |
| *Asset  retirement obligation (Note 7)*          | * *   | ***9,482***   | *** ***  | ***8,302***   | *** *** |
| *Future  income taxes (Note 8)*                  | * *   | ***10,958***  | *** ***  | ***8,638***   | *** *** |
| * *                                         | * *   | ***61,819***  | *** ***  | ***45,545***  | *** *** |
| ***Shareholders’  equity***                 | * *   | *** ***  | *** ***  | *** ***  | *** *** |
| *Share  Capital (Note 10)*                       | * *   | ***162,276*** | *** ***  | ***135,815*** | *** *** |
| *Equity  portion of preferred shares (Note 10)*  | * *   | ***2,320***   | *** ***  | ***—***  | *** *** |
| *Contributed  surplus (Note 10)*                 | * *   | ***11,372***  | *** ***  | ***6,391***   | *** *** |
| *Deficit*                                        | * *   | ***(12,319*** | ***)***       | ***(1,406***  | ***)***      |
| * *                                         | * *   | ***163,649*** | *** ***  | ***140,800*** | *** *** |
| *Related  party transactions (Note 11)*          | * *   | *** ***  | *** ***  | *** ***  | *** *** |
| *Contingencies  and commitments (Note 13)*       | * *   | *** ***  | *** ***  | *** ***  | *** *** |
| *Subsequent  events (Note 15)*                   | * *   | *** ***  | *** ***  | *** ***  | *** *** |
| * *                                         | * *   | ***$***       | ***225,468*** | *** ***  | ***$***      | ***186,345*** | *** *** |

 

*See accompanying notes to theconsolidated financial statements*

Approved by the Board
| Greg S. Noval |   | Michael Coolen |
|---------------|--------|----------------|
| Director      |   | Director       |

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CONSOLIDATED STATEMENTS OF OPERATIONS AND DEFICIT

YEARS ENDED DECEMBER 31

*(Thousands of dollars except per share amounts)*
| ** **                                   | ** ** | **2006**    | ** **  | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------|------------|-------------|-------------|------------|------------|------------|------------|
| **Revenue**                                  | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** |
| Oil and gas                                  | ** ** | **$**       | **49,428**  | ** ** | **$**      | **55,223** | ** ** | **$** | **39,299** | ** ** |
| Transportation                               | ** ** | **(662**    | **)**       | **(678**   | **)**      | **(615**   | **)**      |
| Royalties net of  royalty tax credit         | ** ** | **(8,245**  | **)**       | **(9,716** | **)**      | **(5,805** | **)**      |
|                                         | ** ** | **40,521**  | ** **  | **44,829** | ** ** | **32,879** | ** ** |
| **Expenses**                                 | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** |
| Production and  operating                    | ** ** | **9,042**   | ** **  | **7,239**  | ** ** | **7,151**  | ** ** |
| General and  administration (Note 5)         | ** ** | **9,312**   | ** **  | **5,398**  | ** ** | **4,614**  | ** ** |
| Interest                                     | ** ** | **2,047**   | ** **  | **1,015**  | ** ** | **1,104**  | ** ** |
| Depletion,  amortization and accretion       | ** ** | **25,686**  | ** **  | **23,539** | ** ** | **22,177** | ** ** |
| Stock based  compensation                    | ** ** | **5,891**   | ** **  | **3,657**  | ** ** | **2,612**  | ** ** |
|                                         | ** ** | **51,978**  | ** **  | **40,848** | ** ** | **37,658** | ** ** |
| Income (loss) from  operations               | ** ** | **(11,457** | **)**       | **3,981**  | ** ** | **(4,779** | **)**      |
| Other income (expense)                       | ** ** | **459**     | ** **  | **(715**   | **)**      | **493**    | ** ** |
| Income (loss) before  income taxes           | ** ** | **(10,998** | **)**       | **3,266**  | ** ** | **(4,286** | **)**      |
| Income taxes  (reduction)                    | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** |
| Capital                                      | ** ** | **33**      | ** **  | **129**    | ** ** | **261**    | ** ** |
| Future income  tax (reduction) (Note 8)      | ** ** | **(118**    | **)**       | **81**     | ** ** | **(1,523** | **)**      |
|                                         | ** ** | **(85**     | **)**       | **210**    | ** ** | **(1,262** | **)**      |
| Net Income (loss)                            | ** ** | **(10,913** | **)**       | **3,056**  | ** ** | **(3,024** | ** ** |
|                                         | ** ** | ** **  | ** **  | ** ** | ** ** | ** ** | ** ** |
| Deficit, beginning of  year                  | ** ** | **(1,406**  | **)**       | **(4,462** | **)**      | **(312**   | **)**      |
| Accounting Change (Note  2)                  | ** ** | ** **  | ** **  | ** ** | ** ** | **(1,126** | **)**      |
| Deficit, end of year                         | ** ** | **$**       | **(12,319** | **)**      | **$**      | **(1,406** | **)**      | **$** | **(4,462** | **)** |
| Basic Income (loss) per  share (Note 10(k))  | ** ** | **$**       | **(0.09**   | **)**      | **$**      | **0.03**   | ** ** | **$** | **0.03** | ** ** |
| Diluted income (loss) per share (Note 10(k)) | ** ** | **$**       | **(0.09**   | **)**      | **$**      | **0.03**   | ** ** | **$** | **0.03** | ** ** |

 

 

*See accompanying notes to consolidatedfinancial statements*

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CONSOLIDATED STATEMENTSOF CASH FLOWS

YEARS ENDED DECEMBER 31

*(Thousands of dollars)*
| ** **                                                                    | ** **   | **2006**      | ** **    | **2005**      | ** **   | **2004**      | ** **   |
|-------------------------------------------------------------------------------|--------------|---------------|---------------|---------------|--------------|---------------|--------------|
| ***Cash  provided by (used in) :***                                           | *** *** | *** ***  | *** ***  | *** ***  | *** *** | *** ***  | *** *** |
| ***Operations***                                                              | *** *** | *** ***  | *** ***  | *** ***  | *** *** | *** ***  | *** *** |
| *Net Income (loss)*                                                           | *** *** | ***$***       | ***(10,913*** | ***)***       | ***$***      | ***3,056***   | *** *** | ***$*** | ***(3,024*** | ***)*** |
| *Items not involved in cash for  operations*                                  | *** *** | *** ***  | *** ***  | *** ***  | *** *** | *** ***  | *** *** |
| *Depletion,  depreciation and accretion*                                      | *** *** | ***25,686***  | *** ***  | ***23,539***  | *** *** | ***22,177***  | *** *** |
| *Stock  based compensation*                                                   | *** *** | ***5,891***   | *** ***  | ***3,657***   | *** *** | ***2,612***   | *** *** |
| *Accretion  expense for preferred shares*                                     | *** *** | ***357***     | *** ***  | ***—***  | *** *** | ***—***  | *** *** |
| *Forfeiture  of Nova Scotia offshore term and security deposit*               | *** *** | ***558***     | *** ***  | ***—***  | *** *** | ***—***  | *** *** |
| *Loss on  investments*                                                        | *** *** | ***600***     | *** ***  | ***—***  | *** *** | ***—***  | *** *** |
| *Future  income tax (reduction)*                                              | *** *** | ***(118***    | ***)***       | ***81***      | *** *** | ***(1,523***  | ***)***      |
| * *                                                                      | *** *** | ***22,061***  | *** ***  | ***30,333***  | *** *** | ***20,242***  | *** *** |
| *Change in non cash working  capital (Note 3)*                                | *** *** | ***(8,453***  | ***)***       | ***11***      | *** *** | ***(2,541***  | ***)***      |
| * *                                                                      | *** *** | ***13,608***  | *** ***  | ***30,344***  | *** *** | ***17,701***  | *** *** |
| ***Financing***                                                               | *** *** | *** ***  | *** ***  | *** ***  | *** *** | *** ***  | *** *** |
| *Issue of shares*                                                             | *** *** | ***27,990***  | *** ***  | ***20,316***  | *** *** | ***12,673***  | *** *** |
| *Redemption (issue) of Nova  Scotia offshore term and security deposits, net* | *** *** | ***(963***    | ***)***       | ***(252***    | ***)***      | ***9,670***   | *** *** |
| *Convertible preferred share  issue*                                          | *** *** | ***17,455***  | *** ***  | ***—***  | *** *** | ***—***  | *** *** |
| *Increase (repayment) of  revolving production loan*                          | *** *** | ***(4,941***  | ***)***       | ***2,101***   | *** *** | ***(1,800***  | ***)***      |
| * *                                                                      | *** *** | ***39,541***  | *** ***  | ***22,165***  | *** *** | ***20,543***  | *** *** |
| ***Investing  activities***                                                   | *** *** | *** ***  | *** ***  | *** ***  | *** *** | *** ***  | *** *** |
| *Acquisition of oil and gas  assets*                                          | *** *** | ***—***  | *** ***  | ***—***  | *** *** | ***(1,070***  | ***)***      |
| *Exploration and development  expenditures*                                   | *** *** | ***(59,548*** | ***)***       | ***(44,083*** | ***)***      | ***(41,151*** | ***)***      |
| *Purchase of investments*                                                     | *** *** | ***(3,106***  | ***)***       | ***—***  | *** *** | ***—***  | *** *** |
| *Disposal of investments*                                                     | *** *** | ***2,506***   | *** ***  | ***—***  | *** *** | ***—***  | *** *** |
| *Change in non-cash working  capital (Note 3)*                                | *** *** | ***2,539***   | *** ***  | ***1,647***   | *** *** | ***(3,626***  | ***)***      |
| * *                                                                      | *** *** | ***(57,609*** | ***)***       | ***(42,436*** | ***)***      | ***(45,847*** | ***)***      |
| *Increase (decrease) in cash and  short term investments*                     | *** *** | ***(4,460***  | ***)***       | ***10,073***  | *** *** | ***(7,603***  | ***)***      |
| *Cash and short term  investments, beginning of year*                         | *** *** | ***11,798***  | *** ***  | ***1,725***   | *** *** | ***9,328***   | *** *** |
| *Cash and short term investments, end of year*                                | *** *** | ***$***       | ***7,338***   | *** ***  | ***$***      | ***11,798***  | *** *** | ***$*** | ***1,725*** | *** *** |

 

*See accompanying notes to consolidated financialstatements*

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NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2006 AND 2005

*(Tabular amounts in thousands except per share amounts)*

 

Note 1  Accounting Policies

a)              Principlesof consolidation - The consolidated financial statements include the accountsof the Corporation and the accounts of its wholly-owned subsidiaries.

b)             Cashand short-term investments - Cash and short-term investments consist ofbalances with banks and investments in highly liquid short-term deposits with amaturity date of less than ninety days.

c)              Depletionand Amortization – Canadian Superior Energy Inc. is engaged in the acquisition,exploration, development and production of oil and gas in Canada and Trinidadand Tobago. The Corporation follows the full-cost method of accounting for oiland gas operations whereby all costs relating to the acquisition of,exploration for and development of oil and gas reserves are capitalized.  Such costs include land acquisition costs,geological and geophysical expenses, carrying charges on non-producingproperties, costs of drilling both productive and nonproductive wells, costs ofproduction equipment and overhead charges related to acquisition, explorationand development activities.

The costs are amortized using the unit-of-production method based uponthe estimated proved oil and gas reserves, before royalties, as determined bythe Corporation’s independent engineers. Oil and gas reserves and productionare converted into equivalent units based upon relative energy content.

Costs of acquiring and evaluating unproved properties are initiallyexcluded from depletion calculations. These unevaluated properties are assessed periodically to ascertainwhether impairment has occurred.  Whenproved reserves are assigned or the property is considered to be impaired, thecost of the property or the amount of the impairment is added to costs subjectto depletion calculations.

The Corporation performs a ceiling test in a two-stage test performedat least annually:

i)                 Impairmentis recognized if the carrying value of the oil and gas assets less accumulateddepletion and amortization and the lesser of cost and fair value of unprovenproperties exceeds the estimated future cash flows from proved oil and gasreserves, on an undiscounted basis, using forecast prices and costs.

ii)              Ifimpairment is indicated by applying the calculations described in i) above, theCorporation will measure the amount of the impairment by comparing the carryingvalue of the oil and gas assets less accumulated depletion and amortization andthe lesser of cost and fair value of unproven properties to the estimatedfuture cash flows from the proved and probable oil and gas reserves, discountedat the Corporation’s credit-adjusted risk-free rate of interest, using forecastprices and costs. Any impairment is included in earnings for the year.

Proceeds received from disposals of properties and equipment are creditedagainst capitalized costs unless the disposal would alter the rate of depletionand depreciation by more than 20%, in which case a gain or loss on disposal isrecorded. Amortization of other equipment is provided on a diminishing balancebasis at rates ranging from 20% to 100% per annum.  Gains and losses from disposals are includedin income.

d)             Joint Ventures - TheCorporation’s exploration and development activities related to oil and gas areconducted jointly with others,

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which may include related parties (see Note 11). The accounts reflectonly the Corporation’s proportionate interest in such activities.

e)              IncomeTaxes - The Corporation follows the asset and liability method of accountingfor future income taxes.  Under thismethod, future income tax assets and liabilities are recorded based ontemporary differences between the carrying amount of balance sheet items andtheir corresponding tax bases.  Inaddition, the future benefits of income tax assets, including unused taxlosses, are recognized, subject to a valuation allowance, to the extent that itis more likely than not that such future benefits will ultimately berealized.  Future income tax assets andliabilities are measured using enacted tax rates and laws expected to applywhen the tax liabilities or assets are to be either settled or realized.

f)                Revenuerecognition - Revenue from the sale of oil and gas is recognized based onvolumes delivered to customers at contractual delivery points and rates.  The costs associated with the delivery,including operating and maintenance costs, transportation, and production-basedroyalty expenses are recognized in the same period in which the related revenueis earned and recorded.

g)             Flow-throughshares - The Corporation, from time to time, issues flow-through shares tofinance a portion of its oil and gas exploration activities.  The exploration and development expendituresfunded by flow-through shares are renounced to subscribers in accordance withthe Income Tax Act (Canada).  Theestimated value of the tax pools foregone is reflected as a reduction in sharecapital with a corresponding increase in the future income tax liability at thetime the relevant expenditures are renounced.

h)             MeasurementUncertainty - The preparation of financial statements in conformity withCanadian generally accepted accounting principles requires the Corporation’smanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements, and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ materially from those estimates. The amountsrecorded for depletion and depreciation of petroleum and natural gas propertiesand the provision for asset retirement obligations are based on estimates. Theceiling test is based on estimates of proven reserves, production rates, oiland gas prices and other relevant assumptions. By their nature, these estimatesare subject to measurement uncertainty and the effect on the financialstatements of changes in such estimates, in future periods, could besignificant.

i)                 Pershare amounts – Basic earnings per share is calculated by dividing incomeavailable to common shareholders by the weighted average number of commonshares outstanding during the period. The Corporation follows the treasury stock method for the computation ofdiluted per share amounts.  This methodassumes the proceeds from the exercise of dilutive options and warrants areused to purchase common shares at the weighted average market price during theperiod.  The if converted method is usedto calculate the dilutive effect of convertible debentures.

j)                 Foreigncurrency translation: Transaction amounts denominated in foreign currencies aretranslated into their Canadian dollar equivalents at exchange rates prevailingat the transaction dates. Carrying values of monetary assets and liabilitiesreflect the exchange rates at the balance sheet date. Gains and losses ontranslation or settlement are included in determination of net income for thecurrent period.

k)              Stock BasedCompensation - The Corporation accounts for its stock based compensation plansusing the fair value method. Fair 

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value is determined at the grant date using the Black-Scholesoption-pricing model and is recognized over the vesting period of the optionsgranted as stock compensation expense and contributed surplus. The contributedsurplus balance is reduced as the options shares are exercised and the amountinitially recorded is credited to share capital. 

l)                 AssetRetirement Obligation - The Corporation recognizes the estimated liabilityassociated with an asset retirement obligation (“ARO”) in the financialstatements at the time the asset is acquired and the liability is incurred. Theestimated fair value of the ARO liability is recorded as a long term liability,with a corresponding increase in the carrying amount of petroleum and naturalgas properties. The capitalized amount is depleted on a unit-of-productionmethod over the life of the proved reserves. The liability amount is increasedeach reporting period due to the passage of time and the amount of accretion ischarged to earnings in the period. The ARO can also increase or decrease due tochanges in the estimates of timing of cash flows or changes in the originalestimated undiscounted cost. Actual costs incurred upon settlement of the AROare charged against the ARO to the extent of the liability recorded.

m)           ConvertiblePreferred Shares - The Corporation’s convertible debt instruments aresegregated into their debt and equity components at the date of issue, based onthe relative fair market values of these components in accordance with thesubstance of the contractual agreements. The debt component of the instruments is classified as a liability, andrecorded as the present value of the Corporation’s obligation to make futureinterest payments in cash, and settle the redemption value of the instrument incash or in a variable number of shares. The carrying value of the debt component is accreted to the originalface value of the instruments, over their deemed life, using the effectiveinterest method.  The conversion option,which makes up the equity component of the instruments, is recorded using theresidual value approach.  Uponconversion, any gain or loss arising from extinguishment of the debt isrecorded in income of the current period. 

n)             Recentaccounting pronouncements: In January 2005, the Canadian Institute of CharteredAccountants issued new recommendations for the recognition and measurement offinancial instruments, and amendments to the existing presentation anddisclosure standards, effective for interim and annual financial statementswith fiscal years beginning on or after October 1, 2006. Section 3855 FinancialInstruments – Recognition and Measurement establishes standards for recognizingand measuring financial assets, financial liabilities and non-financialderivatives. Section 3861 Financial Instruments – Presentation and Disclosurediscusses the presentation and disclosure of these items. The application ofhedge accounting is covered in Section 3865 Hedges. Section 1530 ComprehensiveIncome establishes standards for reporting and displaying certain gains andlosses, such as unrealized gains and losses related to hedges or otherderivative instruments, outside of net income, in a statement of Comprehensiveincome. Section 3251 Equity establishes standards for the presentation ofequity and changes in equity, including changes arising from those itemsrecorded in comprehensive income. There have also been numerous consequentialamendments to other Sections. Transitional provisions are complex and varybased on the type of financial instruments under consideration. The Corporationhas limited exposure to hedges and financial instruments and feels the effectsof these new standards will be minimal.

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Note 2- Changes in Accounting Policies

**a)****              StockBased Compensation and other Stock Based Payments**

Effective January 1, 2004, the Corporation retroactively adopted thenew Canadian standard for “Stock Based Compensation”. This standard requiresthat companies measure all stock based payments using the fair value method ofaccounting and recognize the compensation expense in their financialstatements.  Per the transitionalprovisions, adoption requires that compensation expense be calculated andrecorded in the statement of operations for options and warrants issued on orafter January 1, 2003.

**b)****             AssetRetirement Obligations**

Effective January 1, 2004 the Corporation retroactively adopted the newCanadian standard for “Asset Retirement Obligations”. This standard requiresthe recognition of the fair value of obligations associated with the retirementof tangible long-lived assets to be recorded in the period the asset is put touse, with the corresponding increase to the carrying amount of the relatedasset. The obligations recognized are statutory, contractual or legalobligations. The liability is accreted over time for changes in the fair valueof the liability through charges to asset retirement accretion which isincluded in depletion, amortization and accretion expense. The costscapitalized to the related assets are amortized to earnings in a mannerconsistent with the depreciation and amortization of the underlying assets.Revisions to the estimated timing of cash flows or to the original estimatedundiscounted costs could also result in an increase or decrease to theobligation. Actual costs incurred upon settlement of the retirement obligationare charged against the obligation to the extent of the liability recorded.Prior to January 1, 2004, the Corporation provided for future site restorationand abandonment costs over the life of the proved reserves on a unit-of-productionbasis.

**c)****               Hedgingrelationships**

The Corporation has implemented new Canadian accounting guidelines forhedging relationships, which addresses the identification, designation, documentation and effectiveness ofhedging transactions for the purposes of applying hedge accounting. It also established conditions forapplying or discontinuing hedge accounting. Under the new guideline, hedgingtransactions must be documented and it must be demonstrated that the hedges aresufficiently effective in order to continue accrual accounting for positionhedges with derivatives. 

**d)****             Impactof  policy changes on 2004 and 2003Financial Statements**

The adoption of the new accounting policiesfor stock based compensation and asset retirement obligations as appliedretroactively with the following impact on the 2003 comparative figures and the2004 opening deficit: 

| Balance Sheet - debit (credit) | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|------------|------------|
| *Petroleum  and natural gas properties*            | ** ** | **$**      | **4,797**  | ** ** |
| Asset  Retirement Obligation                       | ** ** | **(5,979** | **)**      |
| Provision  for Future Site Restoration             | ** ** | **1,634**  | ** ** |
| Future  Income Taxes                               | ** ** | **(174**   | **)**      |
| Contributed  Surplus                               | ** ** | **(1,404** | **)**      |
| Deficit,  end of year                              | ** ** | **1,126**  | ** ** |
| Deficit, beginning of year                         | ** ** | **486**    | ** ** |
|                                                    |            |            |            |  |

 

| Statement of operations - debit (credit) | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------|------------|------------|------------|
| Depletion,  amortization and accretion                            | ** ** | **$**      | **1,027**  | ** ** |
| Future  site restoration                                          | ** ** | **(1,223** | **)**      |
| Stock  based compensation                                         | ** ** | **771**    | ** ** |
| Future  income tax reduction                                      | ** ** | **65**     | ** ** |
| Decrease  in net income                                           | ** ** | **$**      | **640**    | ** ** |
| Loss per share – basic and diluted                           | ** ** | **$**      | **(0.01**  | **)** |

 

**e)****               Adjust2004 Earnings to Reflect Transportation Charges**

The Corporation has implemented new Canadianaccounting standard relating to the presentation of transportation costs.  In prior years it was Canadian industrypractice to net these costs out of revenues. The Corporation has restated revenues for 2004 and prior years toreflect this change.  Transportationcosts were $0.6 million in 2004.  Thischange has no impact on net income or cash flow.

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Note 3 - Changes inNon-Cash Working Capital and other Cash Flow Information
| ** **                                      | ** ** | **2006  Change** | ** ** | **2005  Change** | ** ** | **2004  Change** | ** ** |
|-------------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Accounts  Receivable                            |       | $                | (8,146     | )                | $          | (3,160           | )          | $ | (2,268 | ) |
| Nova  Scotia offshore drilling security deposit |       | —           |       | —           |       | 10,000           |       |
| Prepaid  expenses                               |       | (11              | )          | (181             | )          | (25              | )          |
| Accounts  payable                               |       | 2,243            |       | 4,999            |       | (3,874           | )          |
| Change in non-cash working capital              |       | $                | (5,914     | )                | $          | 1,658            |       | $ | 3,833 |   |
| Related  to:                                    |       |             |       |             |       |             |       |
| Operating  activity                             |       | $                | (8,453     | )                | $          | 11               |       | $ | (2,541 | ) |
| Financing  activity                             |       | —           |       | —           |       | (10,000          | )          |
| Investing  activity                             |       | 2,539            |       | 1,647            |       | (3,626           | )          |
| Change in non-cash working capital              |       | $                | (5,914     | )                | $          | 1,658            |       | $ | 3,833 |   |
|                                            |       |             |       |             |       |             |       |
| Interest  paid during year                      |       | $                | 2,061      |             | $          | 854              |       | $ | 1,104 |   |
| Taxes paid during year                          |       | $                | —     |             | $          | 143              |       | $ | 271 |   |

 

 

Note 4 – Nova ScotiaOffshore Term Deposits

Under the terms of thelicenses referred to in Note 13(a), the Corporation has assigned term depositstotaling $14,805,000 (2005 - $14,421,000). Accordingly, this amount has been classified as a non-currentasset.  To the extent that theexpenditures are not incurred within the period allowed, the Corporation wouldforfeit its proportionate share of any remaining deposits relating to theunexpended work commitment. During 2006 $581,306 (2005 - $nil) was forfeitedwhich has been expensed in the period (see note 13(a)).  The following table summarizes the workcommitment and work deposit which would be forfeited in proportion to theamount of work commitment not completed by the expiry date referred to in Note13(a):
| License | ** ** | **Work Deposit** | ** ** | **Remaining   Commitment** | ** ** | **Expiry Date** | ** **         |
|---------|------------|-----------------------|------------|---------------------------------|------------|----------------------|--------------------|
| EL 2406 |       | $                     | 11,027,932 |                            | $          | 40,962,046           |               | December  31, 2007 |   |
| EL 2412 |       | $                     | 125,000    |                            | —     |                 | December  31, 2007 |   |
| EL 2413 |       | $                     | 125,000    |                            | —     |                 | December  31, 2007 |   |
| EL 2415 |       | $                     | 3,214,250  |                            | $          | 12,857,000           |               | December  31, 2008 |   |
| EL 2416 |       | $                     | 312,500    |                            | $          | 1,250,000            |               | December  31, 2008 |   |
| Total   |       | $                     | 14,804,682 |                            | $          | 55,069,046           |               |   |   |

 

 

Note 5 - Petroleum and  Natural Gas Properties
|                                                 | ** ** | **Cost** | ** ** | **Accumulated  Depletion and  Amortization** | ** ** | **Net** | ** ** |
|-------------------------------------------------|------------|----------|------------|---------------------------------------------------|------------|---------|------------|
| 2006                                            |       |     |       |                                              |       |    |       |
| Petroleum and  natural gas properties- Canada   |       | $        | 246,751    |                                              | $          | 92,457  |       | $ | 154,294 |   |
| Petroleum and  natural gas properties- Trinidad |       | 31,132   |       | —                                            |       | 31,132  |       |
| Total                                           |       | $        | 277,883    |                                              | $          | 92,457  |       | $ | 185,426 |   |
| 2005                                            |       |     |       |                                              |       |    |       |
| Petroleum and  natural gas properties- Canada   |       | $        | 202,408    |                                              | $          | 67,418  |       | $ | 134,990 |   |
| Petroleum and  natural gas properties- Trinidad |       | 15,394   |       | —                                            |       | 15,394  |       |
| Total                                           |       | $        | 217,802    |                                              | $          | 67,418  |       | $ | 150,384 |   |

 

Future development costs related to proven undevelopedreserves of $9,319,000 (2005 - $7,146,000) have been included in the depletionbase calculation at December 31, 2006.

At December 31,2006, the Corporation has excluded $67,020,000 (2005 - $42,777,000) of oil andgas properties relating to unproved 

----

properties from costssubject to depletion, including $31.1 million (2005 - $15.4 million) relatingto its interests in Trinidad and Tobago inclusive of $4.2 million (2005 - nil)relating to capital costs incurred on behalf of Challenger Energy Corp. thatare not yet due (Note 11). General and administrative expenses totaling$7,554,000 (2005 - $5,937,000), of which $1,208,000 (2005 - $965,000) pertainedto the Nova Scotia project, that were directly related to exploration anddevelopment activities have been capitalized for the year ended December 31,2006. 

The benchmark prices, onwhich the ceiling test is based, are as follows:

|          | ** ** | **WTI Crude Oil** | ** ** | **Exchange Rate** | ** ** | **Edmonton Light Crude** | ** ** | **AECO Natural Gas** | ** ** |
|----------|------------|-----------------------------|------------|------------------------|------------|------------------------------------|------------|--------------------------------|------------|
| **Year** | ** ** | **US$/bbl**                 | ** ** | **US$/CDN$**           | ** ** | **CDN$/bbl**                       | ** ** | **CDN$/mmbtu**                 | ** ** |
| 2007     |       | 62.00                       |       | 0.87                   |       | 70.75                              |       | 7.20                           |       |
| 2008     |       | 60.00                       |       | 0.87                   |       | 68.00                              |       | 7.45                           |       |
| 2009     |       | 58.00                       |       | 0.87                   |       | 65.75                              |       | 7.75                           |       |
| 2010     |       | 57.00                       |       | 0.87                   |       | 64.50                              |       | 7.80                           |       |
| 2011     |       | 57.00                       |       | 0.87                   |       | 64.50                              |       | 7.85                           |       |
| 2012     |       | 57.50                       |       | 0.87                   |       | 65.00                              |       | 8.15                           |       |
| 2013     |       | 58.50                       |       | 0.87                   |       | 66.25                              |       | 8.30                           |       |
| 2014     |       | 59.75                       |       | 0.87                   |       | 67.75                              |       | 8.50                           |       |
| 2015     |       | 61.00                       |       | 0.87                   |       | 69.00                              |       | 8.70                           |       |
| 2016     |       | 62.25                       |       | 0.87                   |       | 70.50                              |       | 8.90                           |       |
| 2017     |       | 63.50                       |       | 0.87                   |       | 71.75                              |       | 9.10                           |       |

 

Benchmark prices increaseat a rate of 2.0% per year for both oil and natural gas after 2017.  Adjustments were made to the benchmark pricesabove, for purposes of the ceiling test, to reflect varied delivery points andquality differentials in the products delivered. For the years ended December31, 2006 and 2005, no ceiling test write-down was required.

Note 6 – RevolvingProduction Loan

At December 31, 2006 theCorporation had a demand revolving production loan facility (the “facility”)with a Canadian chartered bank of $30,000,000 of which it had drawn $7,910,000(2005 - $12,851,000).  The facility bearsinterest at prime plus 0.5%.  Thefacility is secured by a $100 million first floating charge demand debenture onthe assets of the Corporation and a general security agreement covering all ofthe assets of the Corporation.  Thefacility expires April 30, 2007 unless extended.

Note 7 – Asset RetirementObligation

The following tablepresents the reconciliation of the beginning and ending aggregate carryingamount of the obligation associated with the retirement of oil and gasproperties.
| As at December 31 ($000’s) | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Asset Retirement  Obligation, beginning of year     |       | $        | 8,302      |     | $          | 7,177 |   |
| Liabilities Incurred                                |       | 532      |       | 563      |       |
| Accretion expense                                   |       | 648      |       | 562      |       |
| Asset Retirement Obligation, end of year            |       | $        | 9,482      |     | $          | 8,302 |   |

 

The Corporation estimatesthe total undiscounted amount of cash flows required to settle its assetretirement obligation is approximately $17,350,000 (2005 – 15,746,000) whichwill be incurred between 2016 and 2018.

Note 8  Income Taxes 

The net future income taxliability is comprised of:

----

a)              Summaryof temporary differences giving rise to future income tax liability:
|                                                    | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|
| **Future  Tax Liabilities**                        |       |       |       |       |       |
|  Oil and gas assets in excess of tax balances | ** ** | **$**      | **14,135** | ** ** | **$**      | **12,756** | ** ** |
| **Future  Tax Assets**                             | ** ** | ** ** | ** ** | ** ** | ** ** |
|  Share Issue Costs                            | ** ** | **(1,191** | **)**      | **(1,327** | **)**      |
|  Asset Retirement Obligation                  | ** ** | **(2,892** | **)**      | **(2,791** | **)**      |
|                                               | ** ** | **(3,177** | **)**      | **(4,118** | **)**      |
| Net future  income tax liability                   | ** ** | **$**      | **10,958** | ** ** | **$**      | **8,638** | ** ** |

 

b)             Reconciliationof income taxes calculated at the Canadian statutory rate of 34% (2005 – 37.6%,2004 – 38.6%) with actual income taxes:

|                                                  | ** ** | **2006**   | ** **  | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------|------------|------------|-------------|------------|------------|------------|------------|
|                                             | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** |
| Income (loss) before  income taxes               | ** ** | **$**      | **(10,999** | **)**      | **$**      | **3,266**  | ** ** | **$** | **(4,286** | **)** |
| Combined federal and  provincial income tax rate | ** ** | **34.0**   | **%**       | **37.6**   | **%**      | **38.6**   | **%**      |
| Computed income tax expense  (reduction)         | ** ** | **$**      | **(3,740**  | **)**      | **$**      | **1,228**  | ** ** | **$** | **(1,654** | **)** |
| Increase (decrease)  resulting from:             | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** |
| Non deductible  Crown Royalties, net             | ** ** | **1,442**  | ** **  | **1,863**  | ** ** | **1,224**  | ** ** |
| Resource  Allowance                              | ** ** | **(606**   | **)**       | **(2,168** | **)**      | **(1,397** | **)**      |
| Stock based  compensation                        | ** ** | **2,003**  | ** **  | **1,376**  | ** ** | **1,008**  | ** ** |
| Unsuccessful  take over costs                    | ** ** | **725**    | ** **  | **—** | ** ** | **—** | ** ** |
| Tax adjustment  from rate change and other       | ** ** | **58**     | ** **  | **95**     | ** ** | **(704**   | **)**      |
| Tax  reassessments                               | ** ** | **—** | ** **  | **(2,313** | **)**      | **—** | ** ** |
|                                             | ** ** | **$**      | **(118**    | **)**      | **$**      | **81**     | ** ** | **$** | **(1,523** | **)** |

 

Note 9  Convertible Preferred Shares

On February 1, 2006, the Corporation completed a private placement inthe amount of US $15,000,000 by way of the issuance of Units consisting of 5%US Cumulative Redeemable Convertible Preferred Shares (the “Preferred Shares”)and Common Share Purchase Warrants. Each Preferred Share will be convertibleinto forty Common Shares of Canadian Superior (6,000,000 Common Shares inaggregate) at a price of US $2.50 per Common Share. If Canadian Superiorelects, it also has the option to pay the quarterly dividend by way of issuanceof Common Shares at market, based on a 5.75% annualized dividend rate in lieuof the 5% annualized cash dividend rate. In addition, the Preferred Shares areredeemable and retractable five years from the date of issue or earlier,subject to earlier redemption or retraction in certain events. 15,000 Units,each consisting of 10 US $100 Preferred Shares, along with 1,200,000 CommonShare Purchase Warrants were issued to West Coast Asset Management, Inc. TheWarrants comprising part of the Units are exercisable for a period of thirty(36) months from the date of issue at an exercise price of US $3.00 per CommonShare.

The following summarizes the face and carrying value of the liabilityand equity component of the convertible preferred shares at December 31, 2006:
|                                                                          | ** ** | **Liability Component** | ** ** | **Equity Component** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **                                                               | ** ** | **Face Value**          | ** ** | **Carrying   Value** | ** ** | **Fair Value** | ** ** |
| Convertible  Preferred Shares:  Issuance of convertible preferred shares |       | $                            | 17,053     |                      | $          | 15,115 |   | $ | 2,320 |   |
| Accreted (non-cash) interest                                             |       | —                       |       | 357                       |       | — |   |
| Balance, end of year                                                     |       | $                            | 17,053     |                      | $          | 15,472 |   | $ | 2,320 |   |

 

----

Note 10  Share Capital

a)              Authorized:

Unlimited number of common shares

Unlimited number of preferred shares

b)             Votingcommon shares issued:
|                                                    | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **Number**                      | ** ** | **Amount**                      | ** ** | **Number** | ** ** | **Amount** | ** ** |
|   Balance,  beginning of year            |       | 119,135                         |       | 135,650                         |       | 109,806 |   | 114,626 |   |
|                                               |       |                            |       |                            |       |   |   |   |   |
| Issued upon conversion  of purchase warrants       |       | 375                             |       | 948                             |       | 5,500 |   | 10,835 |   |
| Issued upon exercise of  stock options             |       | 1,198                           |       | 1,639                           |       | 852 |   | 1,044 |   |
| Issued in settlement of  lawsuit (Note 13)         |       | 260                             |       | 711                             |       | — |   | — |   |
| Issued for cash                                    |       | 3,500                           |       | 8,301                           |       | — |   | — |   |
| Issued for Canada  Southern Shares                 |       | 472                             |       | 1,116                           |       | — |   | — |   |
| Issued for preferred  share dividend               |       | 276                             |       | 641                             |       | — |   | — |   |
| Issued for cash on  flow-through shares            |       | 6,000                           |       | 15,420                          |       | 2,977 |   | 8,929 |   |
| Tax benefits renounced  on flow-through shares     |       | —                          |       | (2,723                          | )          | — |   | — |   |
| Issue costs, net of  future tax reduction of $285  |       | —                          |       | (649                            | )          | — |   | — |   |
| Issue costs, net of  future tax reduction of $221  |       | —                          |       | —                          |       | — |   | (436 | ) |
| Value of stock  compensation for exercised options |       | —                          |       | 910                             |       | — |   | 652 |   |
|   Balance, end of year                   |       | 131,216                         |       | $                               | 161,964    |   | 119,135 |   | $ | 135,650 |   |
|                                                    |            |                                 |            |                                 |            |  |  |  |  |  |  |

 

c)              Specialwarrants issued:
|                                                   | ** ** | **Number** | ** ** | **Amount** | ** ** | **Number** | ** ** | **Amount** | ** ** |
|---------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Balance, beginning of  year                       |       | —     |       | $          | —     |       | —     |       | $          | — |   |
|                                              |       |       |       |       |       |       |       |       |       |
| Special warrants issued  for cash (Note 10(e)(i)) |       | —     |       | —     |       | 5,500      |       | 11,000     |       |
| Converted upon issuance  of common shares         |       | —     |       | —     |       | (5,500     | )          | (11,000    | )          |
| Balance end of year                               |       | —     |       | $          | —     |       | —     |       | $          | — |   |

 

----

d)             PurchaseWarrants issued:
|                                           | ** ** | **Number** | ** ** | **Amount** | ** ** | **Number** | ** ** | **Amount** | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Balance,  beginning of year               |       | 2,750      |       | $          | 165        |       | —     |       | $          | — |   |
|                                      |       |       |       |       |       |       |       |       |       |
| Issued August  30, 2005 (Note 10(f)(i))   |       | —     |       | —     |       | 2,750      |       | 165        |       |
|                                      |       |       |       |       |       |       |       |       |       |
| Issued February  9, 2006 (Note 10(f)(ii)) |       | 500        |       | 24         |       | —     |       | —     |       |
|                                      |       |       |       |       |       |       |       |       |       |
| Issued June 18,  2006 (Note 10(f)(iii))   |       | 500        |       | 134        |       | —     |       | —     |       |
|                                      |       |       |       |       |       |       |       |       |       |
| Exercised                                 |       | (750       | )          | (11        | )          | —     |       | —     |       |
|                                      |       |       |       |       |       |       |       |       |       |
| Expired                                   |       | (2,500     | )          | —     |       | —     |       | —     |       |
|                                      |       |       |       |       |       |       |       |       |       |
| Balance End of  Year                      |       | 500        |       | 312        |       | 2,750      |       | 165        |       |
|                                      |       |       |       |       |       |       |       |       |       |
| Share capital, end of  year               |       | —     |       | $          | 162,276    |       | —     |       | $          | 135,815 |   |

 

e)              SpecialWarrants

i)                                On August30, 2005 the Corporation filed a short form prospectus qualifying thedistribution of: (a) 5,500,000 common shares and 2,750,000 common sharepurchase warrants upon the exercise of the 5,500,000 special warrants issued onJuly 5th, 6th and 12th, 2005 (as above).

f)                PurchaseWarrants

i)                                Asdescribed in Note 10(e) in August 2005, the Corporation filed a short formprospectus qualifying the distribution of 2,750,000 common share purchasewarrants which expired on June 30, 2006.

ii)                             On February9, 2006, the Corporation completed a private placement financing consisting of1.0 million Units at a price of $2.40 per Unit for gross proceeds of $2.4million. Each Unit consists of one Common Share and one-half of one CommonShare Purchase Warrant. The Warrants comprising part of the Units wereexercisable until December 31, 2006 at an exercise price of $2.40 per commonshare. These warrants have all expired as of December 31, 2006.

iii)                          On June 18,2006 the Corporation issued 500,000 share purchase warrants in arrangingfinancing for the Canada Southern Acquisition. The warrants are exercisableinto 500,000 common shares at US$ 2.50 and expire December 18, 2007.

g)             Stockoptions:

TheCorporation has a stock option plan for its directors, officers, employees andkey consultants.  The exercise price forstock options granted is no less than the quoted market price on the grant datewith options vesting in equal increments over a three year period.  An option’s maximum term is ten years.

----

 

|                                   | ** ** | **2006**                    | ** ** | **2005**                         | ** ** |
|-----------------------------------|------------|-----------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **Number of  Options** | ** ** | **Weighted  Average price** | ** ** | **Number of  Options** | ** ** | **Weighted  Average price** | ** ** |
| Balance,  beginning of year       |       | 9,488                       |       | $                                | 1.83       |   | 7,371 |   | $ | 1.66 |   |
| Prior period option reinstatement |       | —                      |       | —                           |       | 200 |   | 0.80 |   |
| Forfeited                         |       | (747                        | )          | 2.31                             |       | (613 | ) | 1.82 |   |
| Exercised                         |       | (1,198                      | )          | 1.37                             |       | (852 | ) | 1.22 |   |
| Granted                           |       | 5,519                       |       | 2.30                             |       | 3,382 |   | 2.11 |   |
| Balance, end of year              |       | 13,062                      |       | $                                | 2.05       |   | 9,488 |   | $ | 1.83 |   |

 

The following table summarizesinformation about the stock options outstanding at December 31, 2006:
| Options Outstanding | ** ** | ** **                  | ** ** | **Options Exercisable**                                                 | ** ** |
|--------------------------|------------|-----------------------------|------------|------------------------------------------------------------------------------|------------|
| **Exercise Price**  | ** ** | **Number of  options** | ** ** | **Weighted Average of  Remaining  Contractual Life  (years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| $0.80-1.00               |       | 155                         |       | 3.57                                                                         |       | $ | 0.81 |   | 155 |   | $ | 0.81 |   |
| 1.01-1.50                |       | 1,110                       |       | 5.73                                                                         |       | 1.30 |   | 1,110 |   | 1.30 |   |
| 1.51-2.00                |       | 3,748                       |       | 7.54                                                                         |       | 1.79 |   | 2,666 |   | 1.76 |   |
| 2.01-3.00                |       | 8,049                       |       | 9.12                                                                         |       | 2.30 |   | 3,784 |   | 2.31 |   |
| $0.80-3.00               |       | 13,062                      |       | 8.31                                                                         |       | $ | 2.05 |   | 7,715 |   | $ | 1.95 |   |

 

----

 

The following table summarizesinformation about the stock options outstanding at December 31, 2005:
| Options Outstanding | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|
| **Exercise Price**  | ** ** | **Number of  options**  | ** ** | **Weighted Average of  Remaining  Contractual Life  (years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Options** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| $0.80-1.00               |       | 655                          |       | 4.28 |   | $ | 0.82 |   | 655 |   | $ | 0.82 |   |
| 1.01-1.50                |       | 1,145                        |       | 6.89 |   | 1.30 |   | 985 |   | 1.29 |   |
| 1.51-2.00                |       | 4,811                        |       | 8.63 |   | 1.79 |   | 2,209 |   | 1.75 |   |
| 2.00-3.00                |       | 2,877                        |       | 9.00 |   | 2.35 |   | 1,984 |   | 2.40 |   |
| $0.80-3.00               |       | 9,488                        |       | 8.32 |   | $ | 1.83 |   | 5,833 |   | $ | 1.79 |   |

 

A Black-Scholes optionpricing model, with the following weighted average assumptions was used toestimate the fair value of options on the date of the grant, for the inclusionas stock based compensation expense:
|                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
| Risk free  interest rate (%) |       | 4.1      |       | 4.0      |       |
| Expected lives  (years)      |       | 10.0     |       | 10.0     |       |
| Expected  volatility (%)     |       | 44.3     |       | 57.0     |       |
| Dividend per share           |       | 0.00     |       | 0.00     |       |

 

The grant date weightedaverage fair value of options issued during 2006 was $1.41 (2005 - $1.08) peroption.

The impact of stockbased compensation on Contributed Surplus is:
| Contributed Surplus                  | ** ** | **2006**  | ** ** | **2005**   | ** ** |
|-------------------------------------------|------------|-----------|------------|------------|------------|
| Opening Balance                           | ** ** | **$**     | **6,391**  | ** ** | **$**      | **3,386** | ** ** |
| Additions from  issuance of stock options | ** ** | **5,891** | ** ** | **3,657**  | ** ** |
| Reduction from  exercise of stock options | ** ** | **(910**  | **)**      | **(652**   | **)**      |
| Closing balance                           | ** ** | **$**     | **11,372** | ** ** | **$**      | **6,391** | ** ** |

 

h)             On December13, 2006 the Corporation completed a flow-through share agreement to issue6,000,000 common shares for consideration of $15,420,000.

i)                 On December29, 2006 the Corporation completed a private placement of 2,500,000 shares at$2.37 per share for gross proceeds of $5,924,990.

j)                 During theyear ended December 31, 2005, the Corporation entered into flow-through shareagreements to issue 2,976,400 common shares for cash consideration of$8,929,200 and to renounce $8,929,200 of qualified expenditures.

k)              Per shareamounts for Loss per share were calculated using the weighted average number ofcommon shares outstanding of 121,911,000 for 2006 and 112,170,000 for 2005 and106,465,000 for 2004.  The 2006 dilutedearnings per share amounts have not been disclosed as the result isanti-dilutive.  In calculating the 2005diluted earnings per share amounts, 2,109,252 shares were required to be addedto the weighted average number of common shares outstanding.

----

l)                 PreferredShares (see Note 9):
|                                        | ** ** | **Number** | ** ** | **Amount** | ** ** | **Number** | ** ** | **Amount** | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Balance,  beginning of year            |       | —     |       | $          | —     |       | —     |       | $          | — |   |
|                                   |       |       |       |       |       |       |       |       |       |
| Warrant equity  on preferred shares    |       | —     |       | 351        |       | —     |       | —     |       |
| Conversion  Equity on preferred shares |       | —     |       | 1,969      |       | —     |       | —     |       |
| Balance, end of year                   |       | —     |       | $          | 2,320      |       | 0          |       | $          | 0 |   |

 

Note 11 Related Party Transactions

During the year ended December 31, 2006, the Corporationpaid $235,000 (2005 - $73,000, 2004 - $596,000) to a company controlled by adirector, for oilfield construction and $843,000 (2005 - $618,000, 2004 -$32,000) for aircraft rentals to a company controlled by an officer anddirector of the Corporation. During the year, the Corporation also paid $43,456(2005 - $nil, 2004 - $nil) to a company controlled by an officer and directorof the Corporation for consulting services.

In November 2004,the Corporation entered into a participation agreement in the normal course ofoperations with a corporation controlled by an officer and director of theCorporation in respect of the Corporation’s offshore Nova Scotia and offshoreTrinidad and Tobago prospects. During the year the Corporation has incurred$4.2 million in capital costs on behalf of this company, that are not yet dueas per the farm-out agreement. These funds will become due 10 days prior to thespud date of the well the costs were incurred for. These have been recorded asnon-depletable capital costs for 2006 and will be moved to accounts receivablein accordance with the agreement. During 2006 the Corporation also invoicedthis company $90,000 for office rent and costs. The transactions were in the normal course of operations and agreed toby the related company and the Corporation based on extensive negotiations andBoard approval and accordingly had been measured at the exchange amount.

During the year an officerand director was paid $900,782, and an additional $250,000 was accrued butunpaid at year end. All amounts relate to a one time payment pursuant to theterms of an employment contract.

Note 12  Risk Management

The carrying values offinancial assets and liabilities approximate their fair value due to theirshort periods to maturity, or the market interest rate on the revolving productionloan.  The fair value of the convertiblepreferred shares approximated their carrying value. A substantial portion ofthe Corporation’s accounts receivable are with customers and joint venturepartners in the oil and gas industry and are subject to normal industry creditrisks.  Purchasers of the Corporation’soil, gas and natural gas liquids are subject to an internal credit review tominimize the risk of nonpayment.

The Corporation isexposed to foreign currency fluctuations as oil and gas prices received arereferenced to U.S. dollar denominated prices. The Corporation is exposed to a floating interest rate on its revolvingproduction loan.

The Corporation entersinto commodity sales agreements and certain derivative financial instruments toreduce its exposure to commodity price volatility.  These financial instruments are entered intosolely for hedging purposes and are not used for trading or other speculativepurposes.

At December 31, 2006,the Corporation had no contracts in place:

During2006, the Corporation’s hedging activities resulted in a gain of $265,000 (2005– loss of $22,696; 2004 – loss of $496,000) which was recorded as an increase(2005 – decrease; 2004 – decrease) in oil and gas revenues during the period.

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Note 13  Contingenciesand Commitments

a)              NovaScotia:  During 2000, 2001 and 2003, theCorporation acquired six exploration licenses from the Canada-Nova ScotiaOffshore Petroleum Board. These licenses are for a period of nine years intotal, subject to certain requirements being met during the first five years.As a condition of the licenses, the Corporation is required to post security inthe amount of 25% of its work expenditure bids. The deposit is refundable onlyto the extent of approved allowable expenditures.  The duration of the initial five year term,for a given license, can be extended one additional year to six years byposting an additional security deposit in an amount of $250,000. At December31, 2006, as a result of the Corporation having made certain expenditures, theCorporation had fulfilled its work expenditures on two of the six explorationlicenses. During 2006 the corporation forfeited one license and surrendered adeposit in the amount of $581,306 and acquired a 50% interest in two newlicenses in their extension period by paying the Corporations share of thedrilling deposit. The remaining three exploration licenses are currently owned100 percent by the Corporation and have aggregate work expenditure outstandingof $55,069,000, and as such the Corporation has $14,805,000 in term depositsassigned to the Canada – Nova Scotia Offshore Petroleum Board (Note 4).

b)             Trinidadand Tobago: The Corporation is committed to drill three exploration wells onits “intrepid” Block 5(c) under its Block 5(c) Production Sharing Contract(PSC) with the Government of Trinidad and Tobago funded in part by a relatedparty (See Note 11 above) participating on a promoted basis, paying 1/3 ofCanadian Superior’s Block 5(c) exploration program to obtain 25% of CanadianSuperior’s net revenue share of these prospects. Also, once approved by theGovernment of Trinidad and Tobago, the Corporation has the exploration drillingcommitment to drill two wells on the “Mayaro/Guayaguayare” blocks from a jointventure with the Petroleum Company of Trinidad and Tobago Limited(“Petrotrin”).

TheCorporation has also reached an agreement with Maersk A/S  and Beijing Zhiyuan Industries to contractthe Kan Tan Semi-Submersible Drilling Rig for a three well commitment on theCorporation’s Trinidad and Tobago Block 5 (c). The Corporation estimates thatthis commitment will be in the range of US $25.0 to US $30.0 million per welland the wells will be done back to back through 2007.  As at December 31, 2006, US $20 million hadbeen paid.

c)              Flow-throughExpenditures:  At December 31, 2006, theCorporation had yet to incur approximately $14.4 million (2005 - $8.9 million)of Canadian exploration expenses which were renounced for tax purposes.  These expenses must be incurred by December31, 2007.

d)             Litigationand Claims:  The Corporation is involvedin various claims and litigation arising in the ordinary course ofbusiness.  In the opinion of CanadianSuperior the various claims and litigations arising there from are not expectedto have a material adverse effect on the Corporation’s financial position.  The Corporation maintains insurance, which inthe opinion of the Corporation, is in place to address any unforeseen claims.

As atDecember 31, 2005, the Corporation accrued $1,012,000 (inclusive of legalcosts) as a one-time charge to recognize the settlement of a former employee’salleged compensation claims, which was settled in February 2006.  This amount was included as an expense inother income (expense) in the settlement of operations.

e)              LeaseObligations:  The Corporation has enteredinto agreements to lease premises and equipment requiring future minimumpayments totaling $811,151.  Minimumannual payments during the next five fiscal years are as follows:
| 2007 |   | $ | 516,436 |   |
|------|--------|---|---------|--------|
| 2008 |   | $ | 177,045 |   |
| 2009 |   | $ | 89,762  |   |
| 2010 |   | $ | 27,528  |   |
| 2011 |   | $ | 380     |   |

 

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Note 14  Canada Southern

In June 2006, CanadianSuperior made a takeover bid for all of the issued and outstanding shares ofCanada Southern Petroleum Ltd.. Canadian Superior offered 2.75 common shares ofCanadian Superior Energy Inc. plus $2.50 CDN. for each issued and outstandingshare of Canada Southern Petroleum Ltd. On July 17, 2006, Canadian Superiorrevised its offer for Canada Southern Petroleum Ltd. to 2.0 Canadian Superiorshares, $2.50 Cdn. cash and a 25% net profit interest in Canada Southern’sapproximately 927 bcfe of natural gas, being the estimated net amount ofnatural gas Canada Southern attributed to it’s interest in the Canadian ArcticIslands. The offer was for  CanadaSouthern’s approximately 1,100 boe/d of oil and gas production and variouslands including Canada Southern’s Canadian Arctic island interests.  The minimum condition attached to the revisedoffer was not met and there were 171,495 shares tendered to the original offer.Canadian Superior Issued 471,612 shares and paid $430,046.39 to take up theseshares. The costs incurred, including the fair value of the Canadian Superiorshares issued, exceeded the $2,505,615 received on the sale of the 171,495 CanadaSouthern shares. The difference has been recorded as other income (expense) inthe Statement of Income and Retained Earnings.

Note 15  Subsequent Events

On January 16, 2007 Canadian Superiorsigned a new lease for office space. Due to the shortage of office space inCalgary the Corporation incurred an inducement payment of $2.4 million toassume a sublease of approximately 19,000 square feet with total additionalpayments of $735,540 over the four year lease term. The lease assumed iscurrently substantially below the prevailing rates.

Note 16 Reconciliation with United States Generally Accepted AccountingPrincipals

The Corporation follows Canadian generally accepted accounting principles(Canadian GAAP) which differs in some respects with generally acceptedaccounting principles in the United States (U.S. GAAP). Significant differencesin accounting principles that impact the Corporation’s financial statements are described below:

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| ** **                                                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss) in  accordance with Canadian GAAP, as reported                    |       | $        | (10,913    | )        | $          | 3,056    |       | $ | (3,024 | ) |
| Flow Through Shares  (Note 16(a))                                                   |       |     |       |     |       |     |       |
| Income Taxes                                                                        |       | (3,147   | )          | (1,283   | )          | (417     | )          |
| Property Acquisitions  (Note 16(b))                                                 |       |     |       |     |       |     |       |
| Depletion,  amortization and accretion expense                                      |       | 339      |       | 452      |       | 599      |       |
| Income taxes                                                                        |       | (103     | )          | (152     | )          | (206     | )          |
|                                                                                |       |     |       |     |       |     |       |
| Ceiling Test (Note  16(c))                                                          |       |     |       |     |       |     |       |
| Write down of  petroleum and natural gas properties                                 |       | (2,873   | )          | —   |       | (10,000  | )          |
| Income Taxes                                                                        |       | 876      |       | —   |       | 1,439    |       |
| Depletion,  amortization and accretion expense                                      |       | 3,884    |       | 5,181    |       | 4,853    |       |
| Income Taxes                                                                        |       | (1,185   | )          | (1,742   | )          | (1,675   | )          |
|                                                                                |       |     |       |     |       |     |       |
| Stock based  compensation (Note 16(d))                                              |       | —   |       | 3,657    |       | 2,612    |       |
|                                                                                |       |     |       |     |       |     |       |
| Change in valuation  allowance (Note 16(e))                                         |       | 2,811    |       | 1,754    |       | —   |       |
|                                                                                |       |     |       |     |       |     |       |
| Convertible  preferred share treatment (Note 16(f))                                 |       | 1,244    |       | —   |       | —   |       |
|                                                                                |       |     |       |     |       |     |       |
| Net income (loss) in  accordance with U.S. GAAP                                     |       | $        | (9,067     | )        | $          | 10,923   |       | $ | (5,819 | ) |
|                                                                                |       |     |       |     |       |     |       |
| Convertible preferred  share treatment (Note 16(f))                                 |       | (662     | )          | —   |       | —   |       |
|                                                                                |       |     |       |     |       |     |       |
| Net income (loss)  attributable to common shareholders in accordance with U.S. GAAP |       | $        | (9,729     | )        | $          | 10,923   |       | $ | (5,819 | ) |
|                                                                                |       |     |       |     |       |     |       |
| Net income (loss) per  share in accordance with U.S. GAAP                           |       |     |       |     |       |     |       |
|                                                                                |       |     |       |     |       |     |       |
| Basic                                                                               |       | $        | (0.08      | )        | $          | 0.10     |       | $ | (0.05 | ) |
|                                                                                |       |     |       |     |       |     |       |
| Diluted                                                                             |       | $        | (0.08      | )        | $          | 0.10     |       | $ | (0.05 | ) |

 

Years endedDecember 31, 2006 and 2005

(Tabularamounts in thousands of Canadian dollars except per share amounts)

Theapplication of U.S. GAAP results in the following differences to the followingbalance sheet items:
| ** **                                          | ** ** | **Canadian** | ** ** | **United States** | ** ** | **Canadian** | ** ** | **United States** | ** ** |
|-----------------------------------------------------|------------|--------------|------------|------------------------|------------|--------------|------------|------------------------|------------|
| Petroleum and  natural gas properties (Note 16(c))  |       | $            | 185,426    |                   | $          | 155,425      |       | $                      | 150,384    |   | $ | 119,033 |   |
| Convertible  preferred shares (Note 16(f))          |       | 15,472       |       | —                 |       | —       |       | —                 |       |
| Future income  tax liability                        |       | 10,958       |       | —                 |       | 8,638        |       | —                 |       |
| Share capital                                       |       | 162,276      |       | 207,026                |       | 135,815      |       | 177,304                |       |
| Share capital –  preferred shares (Note 16(f)) |       | —       |       | 16,107                 |       | —       |       | —                 |       |
| Contributed  Surplus (Note 16(d))                   |       | 11,372       |       | 5,892                  |       | 6,391        |       | —                 |       |
| Equity portion  of preferred shares (Note 16(f))    |       | 2,320        |       | —                 |       | —       |       | —                 |       |
| Retained Earnings  (deficit)                        |       | $            | (12,319    | )                      | $          | (68,947      | )          | $                      | (1,406     | ) | $ | (59,218 | ) |

 

(a)          Flow Through Shares

TheCorporation finances aportion of its activities with flow through share issues whereby the taxdeductions are renounced to the share subscribers.  The tax cost of the deductions renounced toshareholders is reflected as an increase in the future income tax liability anda reduction from the stated value of the shares. Under U.S. GAAP, share capitalfor flow through shares issued after 1998 is stated at the quoted value of theshares at the date of issuance; the tax cost resulting from deduction renouncements,less any proceeds received in excess of the quoted value of the shares, must beincluded in the determination of the tax expense.

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(b)         Property Acquisitions

Inprior years, the Corporation recorded property acquisitions from relatedparties in exchange for common shares at the exchange amount, pursuant toCanadian GAAP. Under U.S. GAAP, these related party acquisitions are recordedat the seller’s carrying amount. The resulting differences in the recordedcarrying amounts of the properties results in differences in depletion andamortization expense in subsequent years.

(c)          Ceiling Test

AtDecember 31, 2006, the Corporation applied a ceiling test to its petroleum andnatural gas properties. Under Canadian GAAP, the application of this testrequired no adjustment to the carrying value of the Corporation’s petroleum andnatural gas properties.

AtDecember 31, 2006, the Corporation applied a ceiling test to its petroleum andnatural gas properties using December 31, 2006 prices of:
| Gas (per thousand cubic  feet)           |   | $ | 6.25 CDN  |   |
|------------------------------------------|--------|---|-----------|--------|
| Oil and natural gas liquids (per barrel) |   | $ | 67.58 CDN |   |

 

Theapplication of the test resulted in a $2.9 million pre-tax reduction ($2.0 millionafter tax) in the carrying value of the Corporation’s petroleum and natural gasproperties under U.S. GAAP. Under Canadian GAAP, the application of this testrequired no adjustment to the carrying value of the Corporation’s petroleum andnatural gas properties.

AtDecember 31, 2005, the Corporation applied the ceiling test to its petroleumand natural gas properties using December 31, 2005 prices of:
| Gas (per thousand cubic  feet)           |   | $ | 10.35 CDN |   |
|------------------------------------------|--------|---|-----------|--------|
| Oil and natural gas liquids (per barrel) |   | $ | 66.25 CDN |   |

 

Theapplication of the test resulted in no reduction in the carrying value of theCorporation’s petroleum and natural gas properties under either U.S. orCanadian GAAP for 2005.

AtDecember 31, 2004, the Corporation applied a ceiling test to its petroleum andnatural gas properties using December 31, 2004 prices of:
| Gas (per thousand cubic  feet)           |   | $ | 6.35 CDN  |   |
|------------------------------------------|--------|---|-----------|--------|
| Oil and natural gas liquids (per barrel) |   | $ | 50.25 CDN |   |

 

Theapplication of the test resulted in a $10.0 million pre-tax reduction ($8.6million after tax) in the carrying value of the Corporation’s petroleum andnatural gas properties under U.S. GAAP. Under Canadian GAAP, the application ofthis test required no adjustment to the carrying value of the Corporation’spetroleum and natural gas properties.

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Theresulting differences in the recorded carrying amounts of the propertiesresults in differences in depletion, amortization and accretion expenses insubsequent years.

(d)         StockBased Compensation

OnJanuary 1, 2006 the Corporationadopted Statement of Financial Standards (SFAS), “Share-Based Payment.” Thisstatement requires the Corporationto recognize the cost of employee services received in exchange for the Corporation’sequity instruments. Under SFAS No. 123(R) the Corporationis required to record compensation expense over an award’s vesting period basedon the award’s fair value at the date of grant. The Corporationhas elected to adopt SFAS No. 123(R) on a modified prospective basis;accordingly the financial statements for the period prior to January 1, 2006will not include compensation cost calculated under the fair value method.

Priorto January 1, 2006 the Corporationapplied Accounting Principles Board Opinion 25, “Accounting for Stock Issued toEmployees” and therefore recorded the intrinsic value of stock – basedcompensation as expense and applied the disclosure provisions of SFAS No. 123,“Accounting for Stock-Based Compensation.”

(e)          ValuationAllowance

This adjustment reflectsthe accounting of an additional valuation allowance for U.S. GAAP purposesarising from the differences in treatment regarding write downs of Petroleumand Natural Gas Properties and reduced depletion, amortization, and accretionexpense .  The resulting U.S. GAAP futuretax asset is eliminated by a change in this valuation allowance.

(f)            Preferred Shares

The Corporation hasreviewed the Convertible preferred shares and their treatment under SFAS No.150 “accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity” and SFAS No. 133 “accounting for Derivitive Instrumentsand Hedging Activities” While the shares are redeemable they are notmanditoraly redeemable as defined by SFAS No. 150 and therefore would not causethe shares to be recorded as liabilities. In evaluating the embedded conversionoption component in accordance with SFAS No. 133 the shares are indexed to the Corporation’sown stock and would not be required to be accounted for as a derivative underSFAS No. 133 Under EITF 00-19 the preferred shares would be considered“conventional” and therefore not subject to the provisions of EITF 00-19.Accordingly the preferred shares have been accounted for as described by APB 14resulting in the allocation of proceeds between the shares and warrants basedon their relative fair values.

**Additional U.S. GAAP Disclosures**

FAS133

Attimes the Corporation will usederivative financial instruments to manage commodity price exposure. EffectiveJanuary 1, 2001 the Corporationadopted the provisions of FAS 133 which requires that all derivatives berecognized as assets and liabilities on the balance sheet and measured at fairvalue. Gains or losses, including unrealized amounts, on derivatives that havenot been designated as hedges, or were not effective as hedges, are included inincome as they arise.

Forderivatives designated as fair value hedges, changes in the fair value arerecognized in income together with changes in the fair value of the hedgeditem. For derivatives designated as cash flow hedges, changes in the fair valueof the derivatives are recognized in other comprehensive income until thehedged items are recognized in income. Any change in the fair value of thederivatives that is not effective in hedging the changes in future cash flowsis included in income as they arise.

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AtDecember 31, 2006 and 2005 the Corporation did not have any derivativefinancial instruments that were not designated as fair value hedges.

FAS153

InDecember 2004, the FASB issued FAS 153 which deals with the accounting for theexchanges of nonmonetary assets. FAS 153 is an amendment of APB Opinion 29. APBOpinion 29 requires that exchanges of nonmonetary assets should be measuredbased on the fair value of the assets exchanged. FAS 153 amends APB Opinion 29to eliminate the exception from using fair market value for nonmonetaryexchanges of similar productive assets and introduces a broader exception forexchanges of nonmonetary assets that do not have commercial substance. FAS 153is effective for nonmonetary asset exchanges occurring in fiscal periodsbeginning after June 15, 2005.  The Corporationdoes not believe that the application of FAS 153 will have an impact on thefinancial statements.

FAS155 - Accounting for Certain Hybrid Financial Instruments

OnFebruary 16, 2006, FASB issued FASB Statement No. 155, Accounting for CertainHybrid Instruments – an amendment of FASB Statement No. 133 and 140 (FAS 155),which allows an entity to elect to measure certain hybrid financial instrumentsat fair value in their entirety, with changes in fair value recognized inearnings. The fair value election will eliminate the need to separatelyrecognize certain derivatives embedded in hybrid financial instruments underFASB Statement No. 133, Accounting for Derivative Instruments & HedgingActivities. This statement is effective for financial statements issued forfiscal years beginning after September 15, 2006. The Corporation does notexpect there to be any material impact on the Consolidated Financial Statementsupon adoption.

FAS157 - Fair Value Measurement

FASBissued statement of Financial Accounting No. 157 Fair Value Measurement, thisstatement is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears. Early adoption is permitted. The standard provides enhanced guidance forusing fair value to measure assets and liabilities, the information used tomeasure fair value, and the effect of fair value measurement on earnings. Thestandard applies whenever other standards require (or permit) assets orliabilities to be measured at fair value. It does not expand the use of fairvalue in any new circumstances. The Corporation does not expect there to be anymaterial impact on the Consolidated Financial Statements upon adoption of thestandard.

FIN46- Accounting for Variable Interest Entities

InJanuary 2003, the FASB issued Financial Interpretation 46 “Accounting forVariable Interest Entities” (“FIN 46”) that requires the consolidation ofVariable Interest Equities (“VIEs”). VIEs are entities that have insufficientequity or their equity investors lack one or more of the specified elementsthat a controlling entity would have. The VIEs are controlled through financialinterests that indicate control (referred to as “variable interests”). Variableinterests are the rights or obligations that expose the holder of the variableinterest to expected losses or expected residual gains of the entity. Theholder of the majority of an entity’s variable interests is considered the primarybeneficiary of the VIE and is required to consolidate the VIE. In December 2003the FASB issued FIN 46R which superseded FIN 46 and restricts the scope of thedefinition of entities that would be considered VIEs that requireconsolidation. The Corporationdoes not believe FIN 46R results in the consolidation of any additionalentities.

FIN 47 - Conditional Asset Retirement Obligations

Effective31 December 2005, the Corporationadopted FIN 47, Accounting for Conditional Asset Retirement Obligations, an interpretationof FASB Statement No. 143. FIN 47 clarifies that the term conditional assetretirement obligation as used in SFAS No. 143, Accounting for

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AssetRetirement Obligations, refers to a legal obligation to perform an assetretirement activity in which the timing and/or method of settlement areconditional on a future event that may or may not be within the control of theentity. According to FIN 47, uncertainty about the timing and/or method ofsettlement of a conditional asset retirement obligation should be factored intothe measurement of a liability when sufficient information exists rather thanpreclude the need to record a liability. The adoption of this interpretationdid not impact the Corporation’sFinancial Statements.

FIN 48 - Accounting for Uncertainty in Income Taxes

In June 2006, the FASB issued FIN48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASBStatement No. 109.” This interpretation requires that an entity recognize inthe financial statements, the impact of a tax position, if that position ismore likely than not to be sustained on examination by the taxing authorities,based on technical merits of the position. Tax benefits resulting from such aposition should be measured as the amount that is more likely than not on acumulative basis to be sustained on examination. FIN 48 also provides guidanceon de-recognition, classification, interest and penalties on income taxes andaccounting in interim periods. The provisions of FIN 48 are effective forfiscal years beginning after December 15, 2006, with the cumulative effect ofthe change in accounting principle recorded as an adjustment to the January 1,2007 opening retained earnings. The Corporation does not expect there to be anymaterial impact on the Consolidated Financial Statements upon adoption of thestandard.

SAB106

InSeptember 2004, the Securities and Exchange Commission issued Staff AccountingBulletin 106 (“SAB 106”) regarding the application of FAS 143 by oil and gasproducing entities that follow the full cost accounting method. SAB 106 statesthat after the adoption of FAS 143 the future cash flows associated with thesettlement of asset retirement obligations that have been accrued on thebalance sheet should be excluded from the computation of the present value ofestimated future net revenues for purposes of the full cost ceiling testcalculation. The Corporationexcludes the future cash outflows associated with settling asset retirementobligations from the present value of estimated future net cash flows and doesnot reduce the capitalized oil and gas costs by the asset retirement obligationaccrued on the balance sheet. Costs subject to depletion and depreciationinclude estimated costs required to develop proved undeveloped reserves and theassociated addition to the asset retirement obligations. The adoption of SAB106 in the fourth quarter of 2004 did not have a material effect on the resultsof the ceiling test or depletion, depreciation and amortization calculations.

SFAS No. 154 - Accounting Changes and ErrorCorrections

On1 January 2006, the Corporationadopted the provisions of SFAS No. 154, Accounting Changes and ErrorCorrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3. Thisstatement applies to all voluntary changes in accounting principle and changesthe requirements for accounting for and reporting of a change in accountingprinciple. The statement requires retrospective application to prior periods’Financial Statements of a voluntary change in accounting principle versusincluding the cumulative effect of changing to the new accounting principle innet income. SFAS No. 154 carries forward many provisions of APB Opinion No. 20without change, including the provisions related to the reporting of a changein accounting estimate, a change in the reporting entity, and the correction ofan error. The adoption of this standard did not impact the Corporation’sFinancial Statements.

SFASNo. 159 - The Fair Value Option for Financial Assets and Financial Liabilities

InFebruary 2007, the FASB issued SFAS No. 159, The Fair Value Option forFinancial Assets and Financial Liabilities, including an amendment of FASBStatement No. 115 (SFAS No. 159). This statement permits entities to choose tomeasure many financial instruments and certain other items at fair value thatare not currently required to be measured at fair value and establishespresentation

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anddisclosure requirements designed to facilitate comparisons between entitiesthat choose different measurement attributes for similar types of assets andliabilities. SFAS No. 159 is effective on January 1, 2008. The Corporationis currently evaluating the impact of this standard on its FinancialStatements.

PRESENTATION

Thereare different presentations between Canadian and U.S. GAAP which are asfollows:

1)             No subtotal is permitted under U.S.GAAP within cashflow from operations on the statement of cashflows.

2)            Under U.S. GAAP, there is nodifference between net income and other comprehensive income.

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