**Exhibit99.2**

MANAGEMENT’S REPORT TO THE SHAREHOLDERS

The preparation ofthe accompanying consolidated financial statements in accordance withaccounting principles generally accepted in Canada with a reconciliation togenerally accepted accounting principles in the United States is theresponsibility of management.  Financialinformation contained elsewhere in this Annual Report is consistent with thatin the consolidated financial statements.

Management isresponsible for 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 of internalcontrols, 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 ofDirectors is responsible for ensuring that management fulfills its responsibilitiesfor financial 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.

MEYERS NORRISPENNY LLP are independent auditors appointed by Canadian Superior Energy Inc.’sshareholders. The auditors have audited the consolidated financial statementsin accordance with Canadian generally accepted auditing standards and thestandards established by the Public Company Accounting and Oversight Board(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 THE SHAREHOLDERS

We have auditedthe consolidated balance sheets of Canadian Superior Energy Inc. as at December31, 2006 and 2005 and the consolidated statements of operations and deficit andcash flows for the years then ended.  Thesefinancial statements are the responsibility of the Corporation’smanagement.  Our responsibility is toexpress an opinion on these financial statements based on our audits.

We conducted ouraudits in accordance with Canadian generally accepted auditing standards andthe standards 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,these consolidated financial statements present fairly, in all materialrespects, the financial position of the Corporation as at December 31, 2006 and2005 and the results of its operations and its cash flows for the years thenended in accordance with Canadian generally accepted accounting principles.

The financialstatements as at and for the year ended December 31, 2004 were audited by theother auditors, who expressed an opinion without reservation on thesestatements in their report dated March 31, 2005.
|                 |   |                                          |
|-----------------|--------|-----------------------------------------------|
| CALGARY, CANADA |   | MEYERS NORRIS PENNY LLP             |
|            |   |                                          |
| March 12, 2007  |   | INDEPENDENT REGISTERED  CHARTERED ACCOUNTANTS |

 

sCONSOLIDATED BALANCE 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 pershare 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 toconsolidated financial statements*

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CONSOLIDATED STATEMENTS OF 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 toconsolidated financial statements*

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDEDDECEMBER 31, 2006 AND 2005

*(Tabularamounts in thousands except per share amounts)*

Note 1  Accounting Policies

a)           Principles ofconsolidation - The consolidated financial statements include the accounts ofthe Corporation and the accounts of its wholly-owned subsidiaries.

b)          Cash and short-terminvestments - Cash and short-term investments consist of balances with banksand investments in highly liquid short-term deposits with a maturity date ofless than ninety days.

c)           Depletion andAmortization – 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 amortizedusing the unit-of-production method based upon the estimated proved oil and gasreserves, before royalties, as determined by the Corporation’s independentengineers. Oil and gas reserves and production are converted into equivalentunits based upon relative energy content.

Costs of acquiring andevaluating unproved properties are initially excluded from depletioncalculations.  These unevaluatedproperties are assessed periodically to ascertain whether impairment hasoccurred.  When proved reserves areassigned or the property is considered to be impaired, the cost of the propertyor the amount of the impairment is added to costs subject to depletioncalculations.

The Corporation performsa ceiling test in a two-stage test performed at least annually:

i)                 Impairment isrecognized 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)              If impairment isindicated by applying the calculations described in i) above, the Corporationwill measure the amount of the impairment by comparing the carrying value ofthe oil and gas assets less accumulated depletion and amortization and thelesser of cost and fair value of unproven properties to the estimated futurecash flows from the proved and probable oil and gas reserves, discounted at theCorporation’s credit-adjusted risk-free rate of interest, using forecast pricesand costs. Any impairment is included in earnings for the year.

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Proceeds received fromdisposals of properties and equipment are credited against capitalized costsunless the disposal would alter the rate of depletion and depreciation by morethan 20%, in which case a gain or loss on disposal is recorded. Amortization ofother equipment is provided on a diminishing balance basis at rates rangingfrom 20% to 100% per annum.  Gains andlosses from disposals are included in income.

d)             Joint Ventures - TheCorporation’s exploration and development activities related to oil and gas areconducted jointly with others, which may include related parties (see Note 11).The accounts reflect only the Corporation’s proportionate interest in suchactivities.

e)              Income Taxes - TheCorporation follows the asset and liability method of accounting for futureincome taxes.  Under this method, futureincome tax assets and liabilities are recorded based on temporary differencesbetween the carrying amount of balance sheet items and their corresponding taxbases.  In addition, the future benefitsof income tax assets, including unused tax losses, are recognized, subject to avaluation allowance, to the extent that it is more likely than not that suchfuture benefits will ultimately be realized. Future income tax assets and liabilities are measured using enacted taxrates and laws expected to apply when the tax liabilities or assets are to beeither 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-through shares -The Corporation, from time to time, issues flow-through shares to finance aportion 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 liabilitiesat the date of the financial statements, and the reported amounts of revenuesand expenses 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)              Per share amounts –Basic earnings per share is calculated by dividing income available to commonshareholders by the weighted average number of common shares outstanding duringthe period.  The Corporation follows thetreasury stock method for the computation of diluted per share amounts.  This method assumes the proceeds from theexercise of dilutive options and warrants are used to purchase common shares atthe weighted average market price during the period.  The if converted method is used to calculatethe dilutive effect of convertible debentures.

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j)                 Foreign currencytranslation: 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 on translationor settlement are included in determination of net income for the currentperiod.

k)          Stock Based Compensation- The Corporation accounts for its stock based compensation plans using thefair value method. Fair value is determined at the grant date using theBlack-Scholes option-pricing model and is recognized over the vesting period ofthe options granted as stock compensation expense and contributed surplus. Thecontributed surplus balance is reduced as the options shares are exercised andthe amount initially recorded is credited to share capital. 

l)                 Asset RetirementObligation - The Corporation recognizes the estimated liability associated withan asset retirement obligation (“ARO”) in the financial statements at the timethe asset is acquired and the liability is incurred. The estimated fair valueof the ARO liability is recorded as a long term liability, with a correspondingincrease in the carrying amount of petroleum and natural gas properties. Thecapitalized amount is depleted on a unit-of-production method over the life ofthe proved reserves. The liability amount is increased each reporting perioddue to the passage of time and the amount of accretion is charged to earningsin the period. The ARO can also increase or decrease due to changes in theestimates of timing of cash flows or changes in the original estimatedundiscounted cost. Actual costs incurred upon settlement of the ARO are chargedagainst the ARO to the extent of the liability recorded.

m)           Convertible PreferredShares - The Corporation’s convertible debt instruments are segregated intotheir debt and equity components at the date of issue, based on the relativefair market values of these components in accordance with the substance of thecontractual agreements.  The debt componentof the instruments is classified as a liability, and recorded as the presentvalue of the Corporation’s obligation to make future interest payments in cash,and settle the redemption value of the instrument in cash or in a variablenumber of shares.  The carrying value ofthe debt component is accreted to the original face value of the instruments,over their deemed life, using the effective interest method.  The conversion option, which makes up theequity component of the instruments, is recorded using the residual valueapproach.  Upon conversion, any gain orloss arising from extinguishment of the debt is recorded in income of thecurrent period. 

n)             Recent accountingpronouncements: 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 inAccounting Policies 

**a)****              Stock BasedCompensation and other Stock Based Payments**

Effective January 1, 2004, the Corporationretroactively adopted the new Canadian standard for “Stock Based Compensation”.This standard requires that companies measure all stock based payments usingthe fair value method of accounting and recognize the compensation expense intheir financial statements.  Per thetransitional provisions, adoption requires that compensation expense becalculated and recorded in the statement of operations for options and warrantsissued on or after January 1, 2003.

**b)****              Asset RetirementObligations**

EffectiveJanuary 1, 2004 the Corporation retroactively adopted the new Canadian standardfor “Asset Retirement Obligations”. This standard requires the recognition ofthe fair value of obligations associated with the retirement of tangiblelong-lived assets to be recorded in the period the asset is put to use, withthe corresponding increase to the carrying amount of the related asset. Theobligations recognized are statutory, contractual or legal obligations. Theliability is accreted over time for changes in the fair value of the liabilitythrough charges to asset retirement accretion which is included in depletion,amortization and accretion expense. The costs capitalized to the related assetsare amortized to earnings in a manner consistent with the depreciation andamortization of the underlying assets. Revisions to the estimated timing ofcash flows or to the original estimated undiscounted costs could also result inan increase or decrease to the obligation. Actual costs incurred uponsettlement of the retirement obligation are charged against the obligation tothe extent of the liability recorded. Prior to January 1, 2004, the Corporationprovided for future site restoration and abandonment costs over the life of theproved reserves on a unit-of-production basis.

**c)****              Hedgingrelationships**

TheCorporation has implemented new Canadian accounting guidelines for hedgingrelationships, which addresses the identification, designation, documentationand effectiveness of hedging transactions for the purposes of applying hedgeaccounting. It also established conditions for applying or discontinuing hedgeaccounting. Under the new guideline, hedging transactions must be documentedand it must be demonstrated that the hedges are sufficiently effective in orderto continue accrual accounting for position hedges with derivatives. 

**d)****              Impact of  policy changes on 2004 and 2003 FinancialStatements**

Theadoption of the new accounting policies for stock based compensation and assetretirement obligations was applied retroactively with the following impact onthe 2003 comparative figures and the 2004 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**    | ** ** |
|                                                    |            |            |            |  |

 

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** **
| **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)****              Adjust 2004Earnings to Reflect Transportation Charges**

TheCorporation has implemented new Canadian accounting standard relating to thepresentation of transportation costs.  Inprior years it was Canadian industry practice to net these costs out ofrevenues.  The Corporation has restatedrevenues for 2004 and prior years to reflect this change.  Transportation costs were $0.6 million in2004.  This change has no impact on netincome or cash flow.

Note 3 - Changes in Non-Cash Working Capital and otherCash 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 Scotia Offshore Term Deposits

Under the terms of the licenses referred to in Note13(a), the Corporation has assigned term deposits totaling $14,805,000 (2005 -$14,421,000).  Accordingly, this amounthas been classified as a non-current asset. To the extent that the expenditures are not incurred within the periodallowed, the Corporation would forfeit its proportionate share of any remainingdeposits relating to the unexpended work commitment. During 2006 $581,306 (2005- $nil) was forfeited which has been expensed in the period (see Note13(a)).  The following table summarizes thework commitment 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 – Petroleumand 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 costsrelated to proven undeveloped reserves of****$9,319,000(2005 - $7,146,000) have been included in the depletion base calculation atDecember 31, 2006.

At December 31, 2006, the Corporation has excluded$67,020,000 (2005 - $42,777,000) of oil and gas properties relating to unprovedproperties from costs subject to depletion, including $31.1 million (2005 -$15.4 million) relating to its interests in Trinidad and Tobago inclusive of$4.2 million (2005 – nil) relating to capital costs incurred on behalf ofChallenger Energy Corp. that are not yet due (Note 11). General andadministrative expenses totaling $7,554,000 (2005 - $5,937,000), of which$1,208,000 (2005 - $965,000) pertained to the Nova Scotia project, that weredirectly related to exploration and development activities have beencapitalized 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                   |       | 70.25                              |       | 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 increase at a rate of 2.0% per yearfor both oil and natural gas after 2017. Adjustments were made to the benchmark prices above, for purposes of theceiling test, to reflect varied delivery points and quality differentials inthe products delivered. For the years ended December 31, 2006 and 2005, noceiling test write-down was required.

Note 6 – Revolving Production 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.  The facilityexpires April 30, 2007 unless extended.

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Note 7– Asset Retirement Obligation

The following tablepresents the reconciliation of the beginning and ending aggregate carryingamount of the obligation associated with the retirement of oil and gasproperties.
|                                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| As at December  31 ($000’s)                |       |     |       |     |       |
| 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)       Summary of temporary differences giving rise to future incometax 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** | **)**      |
| Loss Carryforward                            | ** ** | **906**    | ** ** | **—** | ** ** |
|                                         | ** ** | **(3,177** | **)**      | **(4,118** | **)**      |
| Net future income tax  liability             | ** ** | **$**      | **10,958** | ** ** | **$**      | **8,638** | ** ** |

 

b)       Reconciliation of income taxes calculated at the Canadianstatutory rate of 34.0% (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** | **)** |

 

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Note 9  Convertible Preferred Shares

On February 1, 2006, the Corporationcompleted a private placement in the amount of US $15,000,000 by way of theissuance of Units consisting of 5% US Cumulative Redeemable ConvertiblePreferred Shares (the “Preferred Shares”) and Common Share Purchase Warrants.Each Preferred Share will be convertible into forty Common Shares of CanadianSuperior (6,000,000 Common Shares in aggregate) at a price of US $2.50 perCommon Share. If Canadian Superior elects, it also has the option to pay thequarterly dividend by way of issuance of Common Shares at market, based on a5.75% annualized dividend rate in lieu of the 5% annualized cash dividend rate.In addition, the Preferred Shares are redeemable and retractable five yearsfrom the date of issue or earlier, subject to earlier redemption or retractionin certain events. 15,000 Units, each consisting of 10 US $100 PreferredShares, along with 1,200,000 Common Share Purchase Warrants were issued to WestCoast Asset Management, Inc. The Warrants comprising part of the Units areexercisable for a period of thirty (36) months from the date of issue at anexercise price of US $3.00 per Common Share.

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)  Voting commonshares 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)                                         OnAugust 30, 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)             Purchase Warrants

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)                                      OnFebruary 9, 2006, the Corporation completed a private placement financingconsisting of 1.0 million Units at a price of $2.40 per Unit for gross proceedsof $2.4 million. Each Unit consists of one Common Share and one-half of oneCommon Share 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)                                   OnJune 18, 2006 the Corporation issued 500,000 share purchase warrants inarranging financing for the Canada Southern Acquisition. The warrants areexercisable into 500,000 common shares at US$ 2.50 and expire December 18,2007.

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g)                                     Stockoptions:

The Corporation has a stock option plan for its directors, officers,employees and key consultants.  Theexercise price for stock options granted is no less than the quoted marketprice on the grant date with options vesting in equal increments over a threeyear period.  An option’s maximum term isten years.
|                                   | ** ** | **2006**           | ** ** | ** **             | ** ** | **2005**           | ** ** | ** **             | ** ** |
|-----------------------------------|------------|--------------------|------------|------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                        | ** ** | **Number of** | ** ** | **Weighted**           | ** ** | **Number of** | ** ** | **Weighted**           | ** ** |
| ** **                        | ** ** | **Options**        | ** ** | **Average price** | ** ** | **Options**        | ** ** | **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 summarizes information about the stock optionsoutstanding at December 31, 2006:
|                         | ** ** | **Options Outstanding** | ** ** | ** **                        | ** ** | **Options Exercisable** | ** ** |
|-------------------------|------------|------------------------------|------------|-----------------------------------|------------|------------------------------|------------|
| ** **              | ** ** | ** **                   | ** ** | **Weighted Average of** | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **                   | ** ** | **Remaining**                     | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Number of**           | ** ** | **Contractual Life **        | ** ** | **Average**                  | ** ** | **Number of** | ** ** | **Weighted Average** | ** ** |
| **Exercise Price** | ** ** | **options**                  | ** ** | **(years)**                       | ** ** | **Exercise Price**      | ** ** | **Options** | ** ** | **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 summarizes information about the stock options outstandingat December 31, 2005:
|                         | ** ** | **Options Outstanding** | ** ** | ** **                   | ** ** | **Options Exercisable** | ** ** |
|-------------------------|------------|------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **              | ** ** | ** **                   | ** ** | **Weighted Average of** | ** ** | ** **                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **                   | ** ** | **Remaining**                | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **Number of**           | ** ** | **Contractual Life **   | ** ** | **Average**                  | ** ** | **Number of** | ** ** | **Weighted Average** | ** ** |
| **Exercise Price** | ** ** | **options**                  | ** ** | **(years)**                  | ** ** | **Exercise Price**      | ** ** | **Options** | ** ** | **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 option pricing model, with the following weightedaverage assumptions was used to estimate the fair value of options on the dateof the grant, for the inclusion as 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 weighted average fair value of options issued during2006 was $1.41 (2005 - $1.08) per option.

The impact of stock based 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)                                     OnDecember 13, 2006 the Corporation completed a flow-through share agreement toissue 6,000,000 common shares for consideration of $15,420,000.

i)                                         OnDecember 29, 2006 the Corporation completed a private placement of 2,500,000shares at $2.37 per share for gross proceeds of $5,924,990.

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

k)                                      Pershare amounts for Loss per share were calculated using the weighted averagenumber of common shares outstanding of 121,911,000 for 2006 and 112,170,000 for2005 and 106,465,000 for 2004.  The 2006diluted earnings 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      |       | —     |       | $          | — |   |

 

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Note 11  Related Party Transactions

During the year endedDecember 31, 2006, the Corporation paid $235,000 (2005 - $73,000, 2004 -$596,000) to a company controlled by a director, for oilfield construction and$843,000 (2005 - $618,000, 2004 - $32,000) for aircraft rentals to a companycontrolled by an officer and director of the Corporation. During the year, theCorporation also paid $43,456 (2005 - $nil, 2004 - $nil) to a companycontrolled by an officer and director of the Corporation for consultingservices.

In November 2004, theCorporation 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.  Duringthe year the Corporation has incurred $4.2 million in capital costs on behalfof this company, that are not yet due as per the farm-out agreement. Thesefunds will become due 10 days prior to the spud date of the well the costs wereincurred for. These have been recorded as non-depletable capital costs for 2006and will be moved to accounts receivable in accordance with the agreement.During 2006 the Corporation also invoiced this company $90,000 for office rentand costs.  The transactions were in thenormal course of operations and agreed to by the related company and theCorporation based on extensive negotiations and Board approval and accordinglyhad been measured at the exchange amount.

During the year anofficer and director was paid $900,782, and an additional $250,000 was accruedbut unpaid at year end. All amounts relate to a one time payment pursuant tothe terms 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 revolvingproduction loan.  The fair value of theconvertible preferred shares approximated their carrying value.  A substantial portion of the Corporation’saccounts receivable are with customers and joint venture partners in the oiland gas industry and are subject to normal industry credit risks.  Purchasers of the Corporation’s oil, gas andnatural gas liquids are subject to an internal credit review to minimize therisk 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, theCorporation had no contracts in place.

During 2006, theCorporation’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  Contingencies and 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”).

The Corporationhas also reached an agreement with Maersk A/S and Beijing Zhiyuan Industries to contract the Kan Tan Semi-SubmersibleDrilling Rig for a three well commitment on the Corporation’s Trinidad andTobago Block 5 (c). The Corporation estimates that this commitment will be inthe range of US $25.0 to US $30.0 million per well and the wells will be doneback to back through 2007.  As atDecember 31, 2006, US $20 million had been 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 at December 31, 2005, the Corporation accrued $1,012,000 (inclusiveof legal costs) as a one-time charge to recognize the settlement of a formeremployee’s alleged compensation claims, which was settled in February2006.  This amount was included as anexpense in other income (expense) in the settlement of operations.

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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     |   |

 

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 Canada Southern’s approximately 1,100 boe/d of oiland gas production and various lands including Canada Southern’s CanadianArctic island interests.  The minimumcondition attached to the revised offer was not met and there were 171,495shares tendered to the original offer. Canadian Superior Issued 471,612 sharesand paid $430,046.39 to take up these shares. The costs incurred, including thefair value of the Canadian Superior shares issued, exceeded the $2,505,615received on the sale of the 171,495 Canada Southern shares. The difference hasbeen recorded as other income (expense) in the Statement of Income and RetainedEarnings.

Note 15  Subsequent Events

On January 16, 2007Canadian Superior signed a new lease for office space. Due to the shortage ofoffice space in Calgary the Corporation incurred an inducement payment of $2.4million to assume a sublease of approximately 19,000 square feet with totaladditional payments of $735,540 over the four year lease term. The leaseassumed is currently substantially below the prevailing rates.

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Note 16 Reconciliationwith United States Generally Accepted Accounting Principals

The Corporation followsCanadian generally accepted accounting principles (Canadian GAAP) which differsin some respects with generally accepted accounting principles in the UnitedStates (U.S. GAAP). Significant differences in accounting principles thatimpact the Corporation’s financial statements are described below:
|                                                                                     | ** ** | **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 ended December 31,2006 and 2005

(Tabular amounts inthousands of Canadian dollars except per share amounts)

The application of U.S.GAAP results in the following differences to the following balance sheet items:
|                                                     | ** ** | **2006**     | ** ** | **2005**               | ** ** |
|-----------------------------------------------------|------------|--------------|------------|------------------------|------------|
| ** **                                          | ** ** | **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 | ) |

 

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(a)           Flow Through Shares

The Corporation financesa portion 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.

(b)           Property Acquisitions

In prior years, theCorporation recorded property acquisitions from related parties in exchange forcommon shares at the exchange amount, pursuant to Canadian GAAP. Under U.S.GAAP, these related party acquisitions are recorded at the seller’s carryingamount. The resulting differences in the recorded carrying amounts of theproperties results in differences in depletion and amortization expense insubsequent years.

(c)           Ceiling Test

At December 31, 2006, theCorporation applied a ceiling test to its petroleum and natural gas properties.Under Canadian GAAP, the application of this test required no adjustment to thecarrying value of the Corporation’s petroleum and natural gas properties.

At December 31, 2006, theCorporation applied a ceiling test to its petroleum and natural gas propertiesusing December 31, 2006 prices of:
| Gas (per thousand cubic  feet)           |   | $ | 6.25 CDN  |   |
|------------------------------------------|--------|---|-----------|--------|
| Oil and natural gas liquids (per barrel) |   | $ | 67.58 CDN |   |

 

The application of thetest resulted in a $2.9 million pre-tax reduction ($2.0 million after tax) inthe carrying value of the Corporation’s petroleum and natural gas propertiesunder U.S. GAAP. Under Canadian GAAP, the application of this test required noadjustment to the carrying value of the Corporation’s petroleum and natural gasproperties.

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

 

The application of thetest resulted in no reduction in the carrying value of the Corporation’spetroleum and natural gas properties under either U.S. or Canadian GAAP for2005.

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At December 31, 2004, theCorporation applied a ceiling test to its petroleum and natural gas propertiesusing December 31, 2004 prices of:
| Gas (per thousand cubic  feet)           |   | $ | 6.35 CDN  |   |
|------------------------------------------|--------|---|-----------|--------|
| Oil and natural gas liquids (per barrel) |   | $ | 50.25 CDN |   |

 

The application of thetest resulted in a $10.0 million pre-tax reduction ($8.6 million after tax) inthe carrying value of the Corporation’s petroleum and natural gas propertiesunder U.S. GAAP. Under Canadian GAAP, the application of this test required noadjustment to the carrying value of the Corporation’s petroleum and natural gasproperties.

The resulting differencesin the recorded carrying amounts of the properties results in differences indepletion, amortization and accretion expenses in subsequent years.

(d)  StockBased Compensation

On January 1, 2006 theCorporation adopted Statement of Financial Standards (SFAS), “Share-BasedPayment.” This statement requires the Corporation to recognize the cost ofemployee services received in exchange for the Corporation’s equityinstruments. Under SFAS No. 123(R) the Corporation is required to recordcompensation expense over an award’s vesting period based on the award’s fairvalue at the date of grant. The Corporation has elected to adopt SFAS No.123(R) on a modified prospective basis; accordingly the financial statementsfor the period prior to January 1, 2006 will not include compensation costcalculated under the fair value method.

Prior to January 1, 2006the Corporation applied Accounting Principles Board Opinion 25, “Accounting forStock Issued to Employees” and therefore recorded the intrinsic value of stock –based compensation 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 purposes arisingfrom the differences in treatment regarding write downs of Petroleum andNatural 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)  PreferredShares

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 theCorporation’s own stock and would not be required to be accounted for as aderivative under SFAS No. 133 Under EITF 00-19 the preferred shares would beconsidered “conventional” and therefore not subject to the provisions of EITF00-19.

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Accordingly the preferredshares have been accounted for as described by APB 14 resulting in theallocation of proceeds between the shares and warrants based on their relativefair values.

**Additional U.S. GAAP Disclosures**

FAS 133

At times the Corporationwill use derivative financial instruments to manage commodity price exposure.Effective January 1, 2001 the Corporation adopted the provisions of FAS 133which requires that all derivatives be recognized as assets and liabilities onthe balance sheet and measured at fair value. Gains or losses, includingunrealized amounts, on derivatives that have not been designated as hedges, orwere not effective as hedges, are included in income as they arise.

For derivativesdesignated as fair value hedges, changes in the fair value are recognized inincome together with changes in the fair value of the hedged item. Forderivatives designated as cash flow hedges, changes in the fair value of thederivatives are recognized in other comprehensive income until the hedged itemsare recognized in income. Any change in the fair value of the derivatives thatis not effective in hedging the changes in future cash flows is included inincome as they arise.

At December 31, 2006 and2005 the Corporation did not have any derivative financial instruments thatwere not designated as fair value hedges.

FAS 153

In December 2004, theFASB issued FAS 153 which deals with the accounting for the exchanges ofnonmonetary assets. FAS 153 is an amendment of APB Opinion 29. APB Opinion 29requires that exchanges of nonmonetary assets should be measured based on thefair value of the assets exchanged. FAS 153 amends APB Opinion 29 to eliminatethe exception from using fair market value for nonmonetary exchanges of similarproductive assets and introduces a broader exception for exchanges ofnonmonetary assets that do not have commercial substance. FAS 153 is effectivefor nonmonetary asset exchanges occurring in fiscal periods beginning afterJune 15, 2005.  The Corporation does notbelieve that the application of FAS 153 will have an impact on the financialstatements.

FAS 155 - Accounting forCertain Hybrid Financial Instruments

On February 16, 2006,FASB issued FASB Statement No. 155, Accounting for Certain Hybrid Instruments –an amendment of FASB Statement No. 133 and 140 (FAS 155), which allows anentity to elect to measure certain hybrid financial instruments at fair valuein their entirety, with changes in fair value recognized in earnings. The fairvalue election will eliminate the need to separately recognize certainderivatives embedded in hybrid financial instruments under FASB Statement No.133, Accounting for Derivative Instruments & Hedging Activities. Thisstatement is effective for financial statements issued for fiscal yearsbeginning after September 15, 2006. The Corporation does not expect there to beany material impact on the Consolidated Financial Statements upon adoption.

FAS 157 - Fair ValueMeasurement

FASB issued statement ofFinancial Accounting No. 157 Fair Value Measurement, this statement iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. Early adoptionis permitted. The standard provides enhanced guidance for using fair value tomeasure assets and liabilities, the information used to measure fair value, andthe effect of fair value measurement on earnings. The standard applies wheneverother standards require (or permit) assets or liabilities to be measured atfair value. It does not expand the use of fair value in any new circumstances.The Corporation does not expect there to be any material impact on theConsolidated Financial Statements upon adoption of the standard.

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FIN 46- Accounting forVariable Interest Entities

In January 2003, the FASBissued Financial Interpretation 46 “Accounting for Variable Interest Entities”(“FIN 46”) that requires the consolidation of Variable Interest Equities(“VIEs”). VIEs are entities that have insufficient equity or their equityinvestors lack one or more of the specified elements that a controlling entitywould have. The VIEs are controlled through financial interests that indicatecontrol (referred to as “variable interests”). Variable interests are therights or obligations that expose the holder of the variable interest toexpected losses or expected residual gains of the entity. The holder of themajority 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 Corporation does not believe FIN 46R results in theconsolidation of any additional entities.

FIN 47 - ConditionalAsset Retirement Obligations

Effective 31 December2005, the Corporation adopted FIN 47, Accounting for Conditional AssetRetirement Obligations, an interpretation of FASB Statement No. 143. FIN 47clarifies that the term conditional asset retirement obligation as used in SFASNo. 143, Accounting for Asset Retirement Obligations, refers to a legalobligation to perform an asset retirement activity in which the timing and/ormethod of settlement are conditional on a future event that may or may not bewithin the control of the entity. According to FIN 47, uncertainty about thetiming and/or method of settlement of a conditional asset retirement obligationshould be factored into the measurement of a liability when sufficientinformation exists rather than preclude the need to record a liability. Theadoption of this interpretation did not impact the Corporation’s FinancialStatements.

FIN 48 - Accounting forUncertainty in Income Taxes

In June 2006, the FASBissued FIN 48, “Accounting for Uncertainty in Income Taxes – an interpretationof FASB Statement No. 109.” This interpretation requires that an entityrecognize in the financial statements, the impact of a tax position, if thatposition is more likely than not to be sustained on examination by the taxingauthorities, based on technical merits of the position. Tax benefits resultingfrom such a position should be measured as the amount that is more likely thannot on a cumulative basis to be sustained on examination. FIN 48 also providesguidance on de-recognition, classification, interest and penalties on incometaxes and accounting in interim periods. The provisions of FIN 48 are effectivefor fiscal years beginning after December 15, 2006, with the cumulative effectof the change in accounting principle recorded as an adjustment to the January1, 2007 opening retained earnings. The Corporation does not expect there to beany material impact on the Consolidated Financial Statements upon adoption ofthe standard.

SAB 106

In September 2004, theSecurities and Exchange Commission issued Staff Accounting Bulletin 106 (“SAB106”) regarding the application of FAS 143 by oil and gas producing entitiesthat follow the full cost accounting method. SAB 106 states that after theadoption of FAS 143 the future cash flows associated with the settlement ofasset retirement obligations that have been accrued on the balance sheet shouldbe excluded from the computation of the present value of estimated future netrevenues for purposes of the full cost ceiling test calculation. TheCorporation excludes the future cash outflows associated with settling assetretirement obligations from the present value of estimated future net cashflows and does not reduce the capitalized oil and gas costs by the assetretirement obligation accrued on the balance sheet. Costs subject to depletionand depreciation include estimated costs required to develop proved undevelopedreserves and the associated addition to the asset retirement obligations. Theadoption of SAB 106 in the fourth quarter of 2004 did not have a materialeffect on the results of the ceiling test or depletion, depreciation andamortization calculations.

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SFAS No. 154 - AccountingChanges and Error Corrections

On 1 January 2006, theCorporation adopted the provisions of SFAS No. 154, Accounting Changes andError Corrections, a replacement of APB Opinion No. 20 and FASB Statement No.3. This statement applies to all voluntary changes in accounting principle andchanges the requirements for accounting for and reporting of a change inaccounting principle. The statement requires retrospective application to priorperiods’ Financial Statements of a voluntary change in accounting principleversus including the cumulative effect of changing to the new accountingprinciple in net income. SFAS No. 154 carries forward many provisions of APBOpinion No. 20 without change, including the provisions related to thereporting of a change in accounting estimate, a change in the reporting entity,and the correction of an error. The adoption of this standard did not impactthe Corporation’s Financial Statements.

SFAS No. 159 - The FairValue Option for Financial Assets and Financial Liabilities

In February 2007, theFASB issued SFAS No. 159, The Fair Value Option for Financial Assets andFinancial Liabilities, including an amendment of FASB Statement No. 115 (SFASNo. 159). This statement permits entities to choose to measure many financialinstruments and certain other items at fair value that are not currentlyrequired to be measured at fair value and establishes presentation 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 Corporation iscurrently evaluating the impact of this standard on its Financial Statements.

PRESENTATION

There are differentpresentations between Canadian and U.S. GAAP which are as follows:

1)             No subtotal is permitted under U.S. GAAP within cashflowfrom 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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