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##### 



Financial Highlights and Achievements
    
    
    2Letter from the Chairman
    
    
    3Exploration and Production
    
    
    5Liquefaction, Refining and Marketing
    
    
    10Wholesale and Retail Distribution
    
    
    15Community Relations, Safety and the Environment
    
    
    18Management Discussion and Analysis
    
    
    21Financials
    
    
    67Glossary and Corporate Directory
    
    
    114




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ü
    
    In January 2006, we entered into an agreement with Shell Overseas Holdings Limited (Shell)
to indirectly purchase all of Shells retail and distribution assets in Papua New Guinea. The
closing of this transaction was subject to the approval of several governmental authorities in
Papua New Guinea, and closed effective October 1, 2006. The Shell asset portfolio is a
distribution network that comprises 4 terminals, 3 depots and 28 retail sites.ü
    
    We commenced drilling the Elk-1 well in February 2006 using our purpose built heliportable
rig. The rig, which was acquired in 2005, has allowed us to explore for oil and gas at a time
when there have been significant delays worldwide due to the prevailing shortage of suitable
drilling equipment. The Elk-1 discovery well was completed on November 23, 2006.ü
    
    In May 2006, InterOil entered into a Memorandum of Understanding with the Government of Papua
New Guinea for natural gas development projects in Papua New Guinea pursuant to which InterOil
will assist in the domestic processing of natural gas in Papua New Guinea.ü
    
    We completed the revamp of our refinery, which began in the second quarter of 2006. The
revamp, which was completed in the third quarter of 2006, has resulted in an improvement in
production economies at our refinery in Papua New Guinea. In addition, the refinery team has
concentrated on optimizing the crude being processed in order to obtain higher yields of
distillates, which are higher margin products. The revamp and crude optimization efforts have
resulted in an improving EBITDA figures for our midstream segment in the third and fourth
quarters of 2006.ü
    
    In August 2006, the credit limit under the BNP facility entered into in 2004 was increased to
$170.0 million. The credit limit is comprised of a $130.0 million facility to provide letters
of credit and short term loans to finance the purchase of crude cargoes and bank guarantees to
facilitate hedging, and a $40.0 million facility that allows us to discount eligible U.S.
dollar receivables and fully cash back loans under the first facility.ü
    
    In December 2006, we renegotiated the terms of the OPIC secured loan where the half yearly
principle payment due in December 2006 and June 2007 of $4.5 million each, have been deferred
until December 31, 2007 and interest previously due on December 31, 2006 and June 30, 2007
were deferred until September 30, 2007. The normal repayment of interest and principal will
recommence on September 30, 2007 and December 31, 2007, respectively.
 INTEROIL 2006 2




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Working Interest in Non Producing Gas Wells
 Location
    
    Gross
    
    
    NetPapua New Guinea
    
    
    5
    
    
    
    3
   Undeveloped Acres
 Location
    
    Gross
    
    
    NetPapua New Guinea
    
    
    8,981,232
    
    
    
    8,223,614Total
    
    
    8,981,232
    
    
    
    8,223,614
   7 INTEROIL 2006




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Expenditure
    
    Amount ($ millions)Property Acquisition Costs
    
    
    0.3Proved Properties
    
    
    Undeveloped Properties
    
    
    0.3Exploration Costs
    
    
    48.2Development Costs
    
    
    Total Expenditure
    
    
    48.5
     Undeveloped Wells
 Type
    
    Gross
    
    NetOil
    
    
    
    
    
    
    Gas
    
    
    1
    
    
    
    0.68Service
    
    
    
    
    
    
    Dry
    
    
    
    
    
    
    Total
    
    
    1
    
    
    
    0.68
      INTEROIL 2006 8




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Strategic Priorities
    
    2006 Progress
    
    2007 InitiativesTarget Acquisitions and
Growth Opportunities in
Papua New Guinea and
the Surrounding Area
    
    ü
    
    Acquired additional interest in PRL 4
and PRL 5 during the year.
    
    üüüü
    
    Evaluate productive potential of the
Stanley gas discovery in PRL 4.
Drill Elevala-2 appraisal well in PRL 5.
Complete evaluation of prospectivity of PPL 244.
Participate in the Papua New Guinea offshore bid round.Position InterOil for
Long-Term Oil and Gas
Business Success
    
    üüü
    
    Natural gas and condensate discovery
at Elk location on existing PPL 238. 
Conducted seismic and airborne gravity
and magnetic surveys on licenses to
expand knowledge base of existing
leads and prospects and to identify
new leads and prospects. 
Modified InterOils Rig 2 to enable
drilling into similar reservoir
conditions encountered in Elk-1.
    
    üüü
    
    Further define the Elk structure and
reservoir by drilling the Elk-2 appraisal
well and conducting 100 miles of
appraisal seismic. 
Conduct detailed 2D seismic surveys
over the Elk discovery and Big Horn
structure on-trend with the
Elk discovery. 
Drill Antelope-1 new structure south
of Elk.ü
    
    Prove up sufficient gas reserves
to support the construction of a
pipeline and liquefaction plant in
Papua New Guinea.
 
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Strategic Priorities
    
    2006 Progress
    
    2007 GoalsCapitalize and Expand on
the Existing Business Assets
    
    ü   Completed refinery optimization
project to improve product slate,
improve reliability and reduce
fuel costs.
    
    ü    Evaluate feasibility of improvements,
modifications and additional
equipment to improve flexibility
and profitability of the refinery.ü    Completed InterOil Power Fuel
project at Moitaka Power Station.
The downstream
business won a
tender to provide IPF to Moitaka
supplied out of the refinery.
    
    ü    Continue to seek out potential
markets for InterOil Power Fuel.ü    Seek profitable
distillate export
opportunities to increase
contribution to fixed costs.ü    Continued with crude optimization
initiatives.
    
    ü    Cost reduction program targeting
10% reduction.Target Acquisitions and
Growth Opportunities in
Papua New Guinea
    
    ü    Commenced consultation with
key stakeholders to discuss ways to
stimulate local demand from the refinery.
    
    ü    Achieve growth in local demand for
products from the refinery.ü    Sign shareholder agreement and
project agreement relating to the
proposed LNG plant.ü    Progressed discussions for LNG
opportunity in Papua New Guinea
with government and other potential.
    
    ü    Complete basis of design and
commence front end engineering.Position InterOil for
Long-Term Oil and Gas
Business Success
    
    ü    Improved refinery profitability to
almost a breakeven position in second
half of 2006.
    
    ü    Maintain the positive momentum
achieved in third and fourth quarter
2006 and achieve a profitable
outcome for 2007.
 INTEROIL 2006      14




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Strategic Priorities
    
    2006 Progress
    
    2007 GoalsCapitalize and
Expand on the
Existing Business
Assets
    
    ü    Secured a contract to provide IPF
to Papua New Guineas Moitaka
Power Station.
    
    ü    Further integrate Shell distribution
assets into the existing InterOil business
to capitalize on cost efficiencies and
operational synergies.ü    Completed the construction of a 2
million liter diesel storage tank at
our terminal in the province of East
Sepik, to augment storage availability at
that location.
    
    ü    Continue to seek out potential markets for
InterOil Power Fuel.

ü    To carry out full retail network plan and
rationalize or expand the retail network as
a result.Target Acquisitions
and Growth
Opportunities in Papua New
Guinea
    
    ü    Finalized the terms of acquisition for
Shell Papua New Guineas distribution
network. The Shell Papua New Guinea business
was transferred to InterOil on
October 1.
    
    ü    Pursue acquisition opportunities in the
aviation distribution business.

ü    Pursue other potential downstream growth
opportunities.ü    Examined other potential downstream growth
opportunities.
    
    ü    To target new mining ventures currently in the
start up phase in Papua New Guinea.ü    To complete a 5-year strategic plan
to identify future growth within the
surrounding region.
 
 17 INTEROIL 2006




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ü
    
    Emissions of substances into, and pollution and contamination of, the atmosphere, waters and
land;ü
    
    Production, use, handling, storage, transportation and disposal of waste, hazardous
substances and dangerous goods;ü
    
    Conservation of natural resources;ü
    
    The protection of threatened and endangered flora and fauna; andü
    
    The health and safety of people.
      INTEROIL 2006 18




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ü
    
    Managing the expectations and demands of benefit streams perceived as a result of the
establishment of the refinery;ü
    
    Managing expectations of community assistance programs to community institutions, and;ü
    
    To manage land acquisition related compensation claims, demands and payments.
      ü
    
    Comply with all applicable laws, regulations and standards and where laws do not exist adopt
and apply standards that reflect the companys commitment to socially and environmentally
responsible behaviors;ü
    
    Maintain close liaison with the Department of Petroleum and Energy and all relevant
Government departments to ensure that InterOil complies with all government legislation and
regulations relevant to its activities in Papua New Guinea;ü
    
    Providing a safe and healthy working environment for all employees and contractors, and
establishing emergency response procedures that allow personnel to respond promptly and
effectively;ü
    
    Establishing community development assistance programs to enhance and improve the standard of
health and education;ü
    
    Pursuing socially responsible community relations initiatives that reflect the communitys
needs, enhance our reputation and recognize the importance of the culture, heritage and
traditional rights of the communities in which we operate;
 19      INTEROIL 2006




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ü
    
    Understanding the traditional and contemporary culture, beliefs and social
dynamics of locals in all project areas with particular reference to land matters,
in order to better manage socio-economic changes in oil and gas exploration and in
our refinery operations in Papua New Guinea;ü
    
    Ensuring community
affairs issues are a major focus in the planning, management and delivery of our
activities, while ensuring that our health, safety and environment operating
procedures are adhered to in every task performed;ü
    
    Communicating with employees, contractors, partners, government and the local
project impacted communities in a transparent, open and proactive manner;ü
    
    Providing cultural awareness information and training to our employees and
contractors at all levels;ü
    
    Ensuring compliance with all applicable industrial relations legislation and
procedures in all employment arrangements with our contractors and
sub-contractors; andü
    
    Providing business development advice and support to appropriate, representative
and sustainable community owned enterprises where they have the capability to
provide cost effective and competent services.
 
 INTEROIL 2006 20




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Segments
    
    OperationsUpstream
    
    ü
    
    Exploration and Production 
Explores and appraises potential
oil and natural gas structures in
Papua New Guinea with a view
to commercializing significant
discoveries.Midstream
    
    ü
    
    Refining, Marketing &
Liquefaction Markets the refined
products it produces in Papua
New Guinea both domestically
and for export. Since early
2006, our business plan and
operating strategy has evolved to
include as a business objective,
the development of an onshore
liquefied natural gas processing
facility in Papua New Guinea.Down-stream
    
    ü
    
    Wholesale and Retail
Distribution Distributes refined
products in Papua New Guinea on
a wholesale and retail basis.Corporate
    
    ü
    
    Corporate Engages in business
development and improvement,
common services and management,
financing and treasury, government
and investor relations. Common
and integrated costs are recovered
from business segments on an
equitable driver basis. Our
corporate segment results also
include consolidation adjustments.
   21 INTEROIL 2006




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This MD&A contains forward-looking statements as defined in U.S. federal and Canadian
securities laws. Such statements are generally identifiable by the terminology used, such as
may, plans, believes, expects, anticipates, intends, estimates, forecasts,
budgets, targets or other similar wording suggesting future outcomes or statements regarding
an outlook. All statements, other than statements of historical fact, included in or incorporated
by reference in this MD&A are forward-looking statements. Forward-looking statements include,
without limitation, statements regarding our plans for expanding our business segments, business
strategy, contingent liabilities, environmental matters, and plans and objectives for future
operations, future capital and other expenditures. By its very nature, such forward-looking
information requires InterOil to make assumptions that may not materialize or that may not be
accurate.
 Each forward-looking statement reflects our current view of future events and is subject to known
and unknown risks, uncertainties and other factors that could cause our actual results to differ
materially from any results expressed or implied by our forward-looking statements. These risks
and uncertainties include, but are not limited to; the exploration and production, the refining
and the distribution businesses are competitive; our refinery has not operated at full capacity
for an extended period of time and our profitability may be materially affected if it is not able
to do so; if we are not able to market all of our refinerys output, we will not be able to
operate our refinery at its full capacity and our financial condition and results of operations
may be materially adversely affected; if our refining margins do not meet our expectations and
our refinery operations are not profitable; we may be required to write down the value of our
refinery; our refinery financial condition may be materially adversely affected if we are unable
to obtain crude feedstocks for our refinery; our refining operations expose us to risks, some of
which are not insured; our hedging activities may incur losses; we may not be successful in our
exploration for oil and gas; if we are unable to renew our petroleum licenses with the Papua New
Guinea government, we may be required to discontinue our exploration activities in Papua New
Guinea; our investments in Papua New Guinea are subject to political, legal and economic risks
that could materially adversely affect their value; new legislative, administrative or judicial
actions that constrain licenses and permits from various government authorities may have a
material affect on the companys operations; weather and unforeseen operating hazards may impact
our operating activities; our significant debt levels and our debt covenants may limit our future
flexibility in obtaining additional financing; our ability to recruit and retain qualified
personnel may have a material adverse effect on our operating results and stock price; Petroleum
Independent and Exploration Corporation can affect our raising of capital through the issuance of
common shares or securities convertible into common shares; compliance with and changes in
environmental laws could adversely affect our performance; you may be unable to enforce your
legal rights against us; changing regulations regarding corporate governance and public
disclosure could cause additional expenses and failure to comply may adversely affect our
reputation and the value of our securities; and the risks described under the heading Risk
Factors in our Annual Information Form.
 Although we believe that the assumptions underlying our forward-looking statements are
reasonable, any of the assumptions could be inaccurate, and, therefore, we cannot assure you that
the forward-looking statements included in this MD&A will prove to be accurate. In light of the
significant uncertainties inherent in our forward-looking statements, the inclusion of such
information should not be regarded as a representation by us or any other person that our
objectives and plans will be achieved.
 INTEROIL 2006 22




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Some of these and other risks and uncertainties that could cause actual results to differ
materially from such forward-looking statements are more fully described under the heading Risk
Factors in our Annual Information Form for the year ended December 31, 2006.
 Readers are cautioned that the foregoing list of important factors affecting forward-looking
information is not exhaustive. Furthermore, the forward-looking information contained in this
quarterly report is made as of the date of this report and, except as required by applicable law,
InterOil does not undertake any obligation to update publicly or to revise any of the included
forward-looking information, whether as a result of new information, future events or otherwise.
The forward-looking information contained in this report is expressly qualified by this cautionary
statement.
 We currently have no production or reserves as defined in Canadian National Instrument 51-101
Standards of Disclosure for Oil and Gas Activities. All information contained in this MD&A
regarding resources are references to undiscovered resources under Canadian National Instrument
51-101, whether stated or not.
 
      23 INTEROIL 2006




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Change
    
    Annual Net EarningsFactor(1)(2)
    
    (+)
    
    Impact(thousands
    
    ($/of dollars)
    
    share)(3)Change in domestic
demand
    
    
    1
    %
    
    
    383
    
    
    
    0.01Change in hydro-
skimming margin
    
    $1.00/bbl
    
    
    6,655
    
    
    
    0.22Change in IPP
pricing margin
for retail and distribution business
    
    0.01 PGK/ litre
    
    
    1,815
    
    
    
    0.06Change in
LIBOR rate
    
    
    1
    %
    
    
    730
    
    
    
    0.03
 (1)
    
    The impact of a change in one factor may be compounded or offset by changes in
other factors. This table does not consider the impact of any inter-relationship among the
factors.(2)
    
    The impact of these factors is illustrative and based off of sales and borrowings
made during the 2006 year.(3)
    
    Per share amounts are based on the number of shares
outstanding at December 31, 2006.
 INTEROIL 2006 26




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Q: What is InterOils business strategy?
 A: To develop a vertically integrated energy company in Papua New Guinea
 
 29 INTEROIL 2006




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Strategic Priorities
    
    2006 Progress
    
    2007 InitiativesCapitalize on and Expand on the Existing
Business Assets
    
    üü
    
    Completed refinery optimization
project, which included the installation
of new generators and modifications
of the furnaces and boilers to improve
reliability and reduce fuel costs.
Secured a contract to provide InterOil
Power Fuel to Papua New Guineas
Moitaka Power Station.
    
    üü
    
    Evaluate feasibility of improvements,
modifications and additional
equipment to improve flexibility and
profitability of the refinery.
Continue to seek out potential markets
for InterOil Power Fuel and distillate
export opportunities to increase
contribution to fixed costs.ü
   

    Cost reduction program targeting
10% reduction.Target Acquisitions and Growth
Opportunities in Papua New Guinea and
the Surrounding Area
    
    üüü
    
    Finalized the terms of acquisition for
Shell Papua New Guineas distribution
network. The Shell Papua New Guinea
business was transferred to InterOil on
October 1. 
Examined other potential downstream
growth opportunities.
Progressed discussions for liquefied
natural gas opportunity in Papua New
Guinea with government and other
potential partners.
    
    üüüü
    
    Pursue opportunities to purchase a
business or assets in the business of
distributing fuel to the aviation sector.
Pursue other potential downstream growth opportunities.
Sign a shareholder agreement relating
to the LNG opportunity in Papua
New Guinea and begin taking steps to
advance project.
Finalize FEED decision and
development plans for LNG project.Position InterOil for Long-Term Oil and
Gas Business Success
    
    üü
    
    Made potential gas and condensate
discovery at Elk location on existing
Petroleum Prospecting License 238.
Conducted seismic and airborne
gravity and magnetic surveys on
licenses to expand knowledge base
of existing prospects and to identify
new prospects.
    
    üü
    
    Obtain further information about the
Elk structure by drilling the Elk-2
appraisal well and conducting 100
miles of appraisal seismic.
Conduct detailed 2D seismic surveys
over the Elk discovery and lead on-trend with the Elk discovery that have
been identified from seismic data and
airborne gravity/magnetic surveys
acquired by the company to date.
 INTEROIL 2006 30




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Consolidated  Operating results
    
    Years ended December 31,($ thousands, unless otherwise indicated)
    
    2006(1)
    
    2005
    
    2004(2)Sales and operating revenues
    
    
    511,088
    
    
    
    481,181
    
    
    
    70,644Interest revenue
    
    
    3,224
    
    
    
    1,831
    
    
    
    382Other non-allocated revenue
    
    
    3,748
    
    
    
    528
    
    
    
    196Total revenue
    
    
    518,060
    
    
    
    483,540
    
    
    
    71,222Cost of sales and operating expenses
    
    
    (499,495
    )
    
    
    (467,247
    )
    
    
    (65,344
    )Office and administration and other expenses
    
    
    (24,430
    )
    
    
    (23,296
    )
    
    
    (14,701
    )Exploration costs
    
    
    (1,658
    )
    
    
    
    
    
    
    (2,903
    )Exploration impairment
    
    
    (417
    )
    
    
    (2,144
    )
    
    
    (35,567
    )Accretion expense
    
    
    (3,741
    )
    
    
    (5,647
    )
    
    
    Earnings before interest, taxes, depreciation and
amortization (unaudited)
    
    
    (11,681
    )
    
    
    (14,794
    )
    
    
    (47,293
    )Depreciation and amortization
    
    
    (12,353
    )
    
    
    (11,037
    )
    
    
    (639
    )Interest expense
    
    
    (17,273
    )
    
    
    (10,987
    )
    
    
    (3,203
    )Loss from ordinary activities before income taxes
    
    
    (41,307
    )
    
    
    (36,818
    )
    
    
    (51,135
    )Income tax expense
    
    
    (2,343
    )
    
    
    (2,832
    )
    
    
    (1,875
    )Non-controlling interest
    
    
    264
    
    
    
    368
    
    
    
    70Total net loss(3)
    
    
    (43,386
    )
    
    
    (39,282
    )
    
    
    (52,940
    )Net loss per share (dollars)
    
    
    (1.47
    )
    
    
    (1.36
    )
    
    
    (2.09
    )Net loss per diluted share (dollars)
    
    
    (1.47
    )
    
    
    (1.36
    )
    
    
    (2.09
    )Total assets
    
    
    488,165
    
    
    
    429,557
    
    
    
    385,842Non current liabilities
    
    
    223,095
    
    
    
    112,273
    
    
    
    87,472Cash flows used in operations
    
    
    (3,246
    )
    
    
    (22,713
    )
    
    
    (79,767
    )Cash dividends declared per share
    
    
    
    
    
    
    
    
    
    
    
 
 (1)
    
    Our wholesale and retail distribution business segment acquired the business
of Shell PNG Limited on October 1, 2006 and information in this table includes the results of the
Shell business from this date.(2)
    
    Our refinery began commercial operations on January 1, 2005. During 2004 we were
still constructing and commissioning our refinery and the costs associated with the construction
and commissioning of our refinery were capitalized rather than expensed. As a result of our
refinery
not having any commercial operations in 2004, our 2004 to 2005 and 2006 results are not
comparable. In addition, our wholesale and retail distribution business segment was acquired on
April 28, 2004 and only operated for eight months during 2004. As a result of our downstream
results not having a full year operations in 2004, our 2004 to 2005 and 2006 results are not
comparable.  31 INTEROIL 2006




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(1)
    
    The movement in the midstream gross margin is calculated as the total midstream revenues
from operations less cost of goods sold and operating expenses. Gross margin does not have a
standardized meaning prescribed by Canadian generally accepted accounting principles and,
therefore, may not be comparable with the calculation of similar measures for other companies.(2)
    
    Other mainly includes movements in office and administration expenses. INTEROIL 2006 32




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ü
    
    The refinery operations experienced a gross margin
improvement of $0.5 million between 2005 and
2006. Although the gross margin suffered in the first
half of 2006 due to shut down days, the positive
impact of the revamp and optimization efforts have
resulted in a net improvement for the year.ü
    
    In addition, the midstream operations experienced a
$4.6 million exchange gain in 2006 as compared to
a $1.4 million exchange loss in 2005 which partially
resulted from the strengthening of the PGK against
the USD. During the year we negotiated improved
rates on our PGK to USD transactions.ü
    
    The refinery experienced higher interest expense
in 2006 as a result of market increases in the
cost of crude feedstock being financed, increases
in the LIBOR indicator rates and increases to
the volume of inventory on hand during the
optimization shutdown.ü
    
    During 2006 we started our midstream liquefaction
segment and up to the end of 2006 we had incurred
$0.7 million of costs relating to the preliminary
stages of a liquefied natural gas plant project.ü
    
    Our downstream business had a $0.7 million
increase in depreciation expense, primarily due
to the acquisition of Shell Papua New Guinea on
October 1, 2006.ü
    
    Our upstream operations experienced lower
accretion expense as a result of a decrease in the
related indirect participation interest liability. The
indirect participation interest liability is decreased
as the obligation to complete the drilling program is
being met.ü
    
    During the year, we recognized a $0.8 million loss
on the impairment of one of our two barges. One of
these barges was sold during the year.ü
    
    Our interest expense for the year has increased as a
result of the $130 million secured loan financing.ü
    
    We incurred a $1.4 million expense relating to the
amendment of the PNG Drilling Ventures indirect
participation interest agreement.
 33     
INTEROIL 2006




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Quarters ended($ thousands unless stated
    
    2006(2),(3)
    
    
    2005 (adjusted)(1),(2)otherwise) (unaudited)
    
    Dec 31
    
    
    Sep 30
    
    
    Jun 30
    
    
    Mar 31
    
    
    Dec 31
    
    
    Sep 30
    
    
    Jun 30
    
    
    Mar 31Sales and operating revenues
    
    
    171,734
    
    
    
    111,372
    
    
    
    124,671
    
    
    
    110,283
    
    
    
    125,216
    
    
    
    129,465
    
    
    
    125,275
    
    
    
    103,584Upstream
    
    
    (337
    )
    
    
    1,290
    
    
    
    2,946
    
    
    
    1,350
    
    
    
    854
    
    
    
    404
    
    
    
    37
    
    
    
    Midstream  Refining and Marketing
    
    
    147,538
    
    
    
    94,687
    
    
    
    106,825
    
    
    
    103,105
    
    
    
    108,625
    
    
    
    115,273
    
    
    
    114,717
    
    
    
    98,051Midstream  Liquefaction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    91,990
    
    
    
    39,527
    
    
    
    37,995
    
    
    
    27,808
    
    
    
    39,044
    
    
    
    32,449
    
    
    
    29,993
    
    
    
    23,715Corporate & Consolidated
    
    
    (67,457
    )
    
    
    (24,132
    )
    
    
    (23,095
    )
    
    
    (21,980
    )
    
    
    (23,307
    )
    
    
    (18,661
    )
    
    
    (19,472
    )
    
    
    (18,182
    )Earnings before interest, taxes, depreciation and
amortization
    
    
    6,541
    
    
    
    1,140
    
    
    
    (10,257
    )
    
    
    (9,105
    )
    
    
    (5,566
    )
    
    
    3,486
    
    
    
    (6,856
    )
    
    
    (5,858
    )Upstream
    
    
    (1,051
    )
    
    
    (1,337
    )
    
    
    (2,262
    )
    
    
    (2,227
    )
    
    
    (2,362
    )
    
    
    (1,655
    )
    
    
    (2,615
    )
    
    
    (1,603
    )Midstream  Refining and Marketing
    
    
    9,144
    
    
    
    1,674
    
    
    
    (8,188
    )
    
    
    (5,230
    )
    
    
    (6,333
    )
    
    
    6,070
    
    
    
    (6,796
    )
    
    
    (3,405
    )Midstream  Liquefaction
    
    
    (396
    )
    
    
    (298
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    1,143
    
    
    
    1,954
    
    
    
    3,559
    
    
    
    (326
    )
    
    
    3,963
    
    
    
    2,522
    
    
    
    2,550
    
    
    
    584Corporate & Consolidated
    
    
    (2,299
    )
    
    
    (853
    )
    
    
    (3,366
    )
    
    
    (1,322
    )
    
    
    (834
    )
    
    
    (3,451
    )
    
    
    5
    
    
    
    (1,434
    )Net income (loss) per segment(4)
    
    
    (3,711
    )
    
    
    (7,553
    )
    
    
    (17,759
    )
    
    
    (14,363
    )
    
    
    (12,165
    )
    
    
    (2,912
    )
    
    
    (12,852
    )
    
    
    (11,353
    )Upstream
    
    
    (1,286
    )
    
    
    (1,540
    )
    
    
    (2,436
    )
    
    
    (2,426
    )
    
    
    (2,452
    )
    
    
    (1,870
    )
    
    
    (2,619
    )
    
    
    (1,608
    )Midstream  Refining and Marketing
    
    
    3,818
    
    
    
    (4,309
    )
    
    
    (13,408
    )
    
    
    (10,052
    )
    
    
    (11,622
    )
    
    
    1,068
    
    
    
    (11,839
    )
    
    
    (8,469
    )Midstream  Liquefaction
    
    
    (396
    )
    
    
    (298
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    (427
    )
    
    
    1,278
    
    
    
    2,426
    
    
    
    (282
    )
    
    
    2,802
    
    
    
    1,460
    
    
    
    1,789
    
    
    
    382Corporate & Consolidated
    
    
    (5,420
    )
    
    
    (2,684
    )
    
    
    (4,341
    )
    
    
    (1,603
    )
    
    
    (893
    )
    
    
    (3,570
    )
    
    
    (183
    )
    
    
    (1,658
    )Net income (loss) per share(4)(dollars)Per Share  Basic
    
    
    (0.13
    )
    
    
    (0.25
    )
    
    
    (0.60
    )
    
    
    (0.49
    )
    
    
    (0.42
    )
    
    
    (0.10
    )
    
    
    (0.45
    )
    
    
    (0.40
    )Per Share  Diluted
    
    
    (0.13
    )
    
    
    (0.25
    )
    
    
    (0.60
    )
    
    
    (0.49
    )
    
    
    (0.42
    )
    
    
    (0.10
    )
    
    
    (0.45
    )
    
    
    (0.40
    )
 
 (1)
    
    Comparative quarterly
results for all quarters during 2005 have
been adjusted and re-presented to include the
adopted accounting treatment for exploration
expenses associated with our $125 million
Indirect Participation Interest Agreement
entered into in February 2005 as reviewed by
our auditors in the third quarter of 2005.
The adjusted results present the quarterly
financial information as if the indirect
participation interest accounting
policy we adopted during the third
quarter of 2005 had been adopted at the
inception of the agreement. See Note 23 to
our unaudited
financial statements for the three and nine
month periods ended September 30, 2006 and
2005.(2)
    
    Our comparative quarterly
results for all quarters during 2005 and
2006 have been represented to confirm with
the INTEROIL 2006      34




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##### Table of Contents



corporate segment. Amounts associated
with these line items are now included in
each operating segments result.(3)
    
    Our September 2006 quarterly results have been represented to separate out our
Midstream-Liquefaction segment from the Midstream-Refining and Marketing segment as the
liquefaction business has become an increasingly important component of our business.(4)
    
    We did not have any discontinued operations or extraordinary items during the
periods covered by this table.       
 
 (1)
    
    The movement in the
midstream gross margin is calculated as the
total midstream revenues from operations
less cost of goods sold and operating
expenses. Gross margin does not have a
standardized meaning prescribed by Canadian
generally accepted accounting principles
and, therefore, may not be comparable with the
calculation of similar measures for
other companies.(2)
    
    Other mainly includes movements in office and administration expenses. 35      INTEROIL 2006




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ü
    
    The refinery operations
experienced a gross margin improvement
of $12.9 million between the 2005
quarter and the 2006 quarter. This is
the result of the positive impact of
the revamp and optimization efforts
which has resulted in a more profitable
product mix in 2006 and lower
associated fuel costs for the refinery.
In addition, the fourth quarter of 2006
benefited from changes that we
negotiated in our low sulphur waxy
residue and naphtha sales contracts.ü
    
    In addition, the midstream
operations experienced a $0.4 million
exchange gain in 2006 as compared to a
$1.2 million exchange loss in 2005 which
partially resulted from the
strengthening of the PGK against the
USD. During the year we negotiated
improved rates on our PGK and USD
transactions.ü
    
    The office and administration and
other costs for the fourth quarter of
2006 have decreased by approximately
$1.1 million. This is largely the result
of a gain on derivative instruments that
were not subject to hedge accounting.ü
    
    During 2006 we started our
midstream liquefaction segment and
during the fourth quarter of 2006 we
incurred $0.4 million of costs relating
to the preliminary stages of a
liquefied natural gas plant project.ü
    
    Our downstream business had a $3.2
million decrease in its net income for
the quarter over the prior year. This
primarily related to product pricing.
The IPP dropped from 1.56 PGK (USD
$0.50) in September to 1.49 PGK (USD
$0.48) at the beginning of January 2007.
As the IPP declined each month, any
inventory holdings purchased in
preceding periods were sold at lower IPP
prices, resulting in lower margins. The
effect of this was compounded by our
acquisition of Shell. Although we gained
additional sales volume in the quarter,
our gross margin declined.Sales volumes for our downstream business
increased from 655 kilolitres per day in
the fourth quarter of 2005 to 1,472
kilolitres per day in the fourth quarter
of 2006.ü
    
    Our upstream operations
experienced lower accretion expense as
a result of a decrease in the related
indirect participation interest
liability. The indirect participation
interest liability is decreased as the
obligation to complete the drilling
program is being met.ü
    
    In 2005 we recognized $1.4
million in exploration expenses,
primarily relating to the costs of
testing the Black Bass and Triceratops
wells. In 2006, there were no similar
exploration costs that were recognized.
The majority of our fourth quarter 2006
expenditures were allocated against the
indirect participation interest
agreement.ü
    
    Depreciation associated with our
midstream and upstream segment
increased as a result of a full
quarter of depreciation being
recognized on our rig and exploration
warehouse and also as the result of
depreciation being recognized on the
capitalized revamp costs.
   
 INTEROIL 2006 36




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Q:
    
    How much property in Papua New Guinea does the InterOil upstream business encompass?A:
    
    InterOil has four exploration licenses and two retention licenses covering approximately 9 million acres.
  Key Upstream Metrics
    
    2006
    
    
    2005Wells drilled
    
    
    1
    
    
    
    2Total wells drilled in eight well indirect participation interest program
    
    
    3
    
    
    
    2Total feet drilled
    
    
    6,0872D seismic miles acquired
    
    
    79
    
    
    
    100Airborne gravity and magnetic survey miles acquired
    
    
    6,244
    
    
    
    3,800Total spent on seismic acquisition ($ millions)
    
    
    6.8
    
    
    
    11.0Total spent on drilling ($ millions)
    
    
    37.9
    
    
    
    22.9
   37      INTEROIL 2006




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Years ended December 31,Upstream  Operating results ($ thousands)
    
    2006
    
    
    2005(1)
    
    
    2004(1)External sales
    
    
    
    
    
    
    
    
    
    
    Inter-segment revenue
    
    
    
    
    
    
    
    
    
    
    Other non-allocated revenue
    
    
    5,249
    
    
    
    1,295
    
    
    
    113Total segment revenue
    
    
    5,249
    
    
    
    1,295
    
    
    
    113Cost of sales and operating expenses
    
    
    
    
    
    
    
    
    
    
    Office and administration and other expenses
    
    
    (5,553
    )
    
    
    (1,738
    )
    
    
    (1,648
    )Exploration costs
    
    
    (1,658
    )
    
    
    
    
    
    
    (2,903
    )Exploration impairment
    
    
    (417
    )
    
    
    (2,145
    )
    
    
    (35,567
    )Impairment expense on barge sale
    
    
    (757
    )
    
    
    
    
    
    
    Accretion expense
    
    
    (3,741
    )
    
    
    (5,647
    )
    
    
    Earnings before interest, taxes, depreciation
and amortization (unaudited)
    
    
    (6,877
    )
    
    
    (8,235
    )
    
    
    (40,005
    )Depreciation and amortization
    
    
    (806
    )
    
    
    (314
    )
    
    
    (13
    )Interest expense
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Loss from ordinary activities before income taxes
    
    
    (7,688
    )
    
    
    (8,549
    )
    
    
    (40,023
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    Total net loss
    
    
    (7,688
    )
    
    
    (8,549
    )
    
    
    (40,023
    )
 
 (1)
    
    Our 2005 and 2004
segment results have been represented to
confirm with the presentation adopted in
2006. Previously, interest revenue and
non-controlling interest were allocated to
the corporate segment. Amounts associated
with these line items are now included in
each operating segments result. INTEROIL 2006      38




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##### Table of Contents



ü
    
    An increase in other revenues of
$3.9 million in 2006 primarily related
to the rental of our company-owned rig
being charged against our indirect
participation interest at current market
day rents. Because we expense the costs
of owning and maintaining this rig, the
amounts charged to the indirect
participation interest liability are
recognized as revenue by our upstream
business segment. The increase is also
contributed by intercompany interest
revenue of $1.4 million received by
Upstream from Corporate on account of
the use of IPI funds. The revenue also
relates to the one-time rental of camp
facilities and providing logistics
support to another exploration company.ü
    
    An increase of $2.7 million,
included in office and administration
and other expenses, related to the
costs of owning and maintaining the
rig.ü
    
    An increase of $1.7 million in
exploration expenses relating to the
seismic program undertaken in 2006. In
2005, all seismic costs were allocated
against our indirect participation
interest liability rather than being
expensed. In 2006, in accordance with
the accounting treatment adopted for the
indirect participation interest
liability, a portion of our exploration
costs were allocated against the
liability, but the remaining component
was recognized as an expense item.ü
    
    A decrease of $1.7 million in
exploration impairment is the result of
the testing costs relating to the Black
Bass and Triceratops wells being
expensed in 2005 whereas in 2006 the
majority of the expense relates to the
acquisition of additional interests in
our PRL 4 and PRL 5 licenses.ü
    
    An increase of $0.8 million for
the impairment expense on a barge
sale. The Company sold one of its two
barges to a third party during the
year.ü
    
    Accretion expense decreased by
$1.9 million in 2006 as a result of a
decrease in the indirect
participation interest liability.
During 2006, the indirect
participation liability has decreased
as the obligation to complete the
drilling program is being met.ü
    
    An increase in depreciation
expense of $0.5 million in 2006 as a
result of a full year of depreciation
being recognized on the rig, offices
and warehouse which were purchased part
way through 2005.
   ü
    
    Drill appraisal
well, Elk-2, and
exploration well
Antelope-1ü
    
    Conduct 100
miles of appraisal
seismic over the Elk
structureü
    
    Drill one well in PRL 5ü
    
    Re-enter and test
the Stanley gas
discovery in PRL 4
  ü
    
    Results from Elk-2 and Antelope-1ü
    
    Ability to attract
and retain staff in a
competitive oil and gas
industryü
    
    Conclusion of an
exploration funding
agreement with an industry
majorü
    
    Proving sufficient
gas reserves to
guarantee the
liquefaction project
 39 INTEROIL 2006




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Q:
    
    How much of the domestic demand
in Papua New Guinea does the
refinery supply?A:
    
    The refinerys output is sufficient
to meet 100% of the domestic demand in
Papua New Guinea.
  Key Refining andMarketing Metrics
    
    2006
    
    
    2005Net income/(loss) ($ millions)
    
    $
    (24.0
    )
    
    $
    (30.9
    )EBITDA ($ millions)
    
    $
    (2.6
    )
    
    $
    (10.5
    )Throughput (barrels per day)(1)
    
    
    19,784
    
    
    
    23,117Cost of production per barrel(2)
    
    $
    3.46
    
    
    $
    3.09Working capital financing cost per barrel of production(2)
    
    $
    1.16
    
    
    $
    0.96Distillates as percentage of production
    
    
    65
    %
    
    
    55
    %
 
 (1)
    
    Throughput per day has been calculated excluding shut down days.(2)
    
    Our cost of production per
barrel and working capital financing cost
per barrel have been calculated based on a
notional throughput. Our actual throughput
has been adjusted to include the throughput
that would have been necessary to produce
the equivalent amount of diesel that we
imported during the year. 
 INTEROIL 2006 40




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41 INTEROIL 2006




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##### Table of Contents



Q:
    
    How do the revamp works and
crude optimization efforts undertaken
in 2006 improve profitability?A:
    
    These initiatives have resulted in
increased yields of higher value
products and lower fuel consumption at
the refinery.
 INTEROIL 2006      42




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##### Table of Contents



+  +  +  +
  +
 
 
 
 ü
    
    Foreign exchange gains in the
second half of 2006 were $4.5 million
compared to $0.1 million for the first
half of 2006. During the year we
negotiated improved rates on our PGK
to USD transactions.ü
    
    The effect of non-hedge
accounted derivatives on earnings
increased by $2.7 million from the
first half to the second half of 2006.
During the second half of the year we
introduced a new derivative instrument
into our risk management program. This
instrument, coupled with the technique
by which we utilize it, was deemed not
to be subject to hedge accounting and
as a result all movements on these
derivative contracts are recognized in
the statement of operations below the
gross margin level.
 43 INTEROIL 2006




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##### Table of Contents



Realized and unrealized gains from
this new risk management instrument are
largely responsible for the $2.7 million
movement between the two periods.
 ü
    
    Borrowing costs increased by $0.7
million in the second half of 2006 due
to the combination of increased LIBOR
rates on our working capital facility
and increased working capital borrowing
requirements as a result of the refinery
holding excess inventory through the
shutdown period. These two factors were
partially offset by decreased LC fees
and the increased utilization of the
cash backing component of our working
capital facility. The cash backing
allows us to reduce the cost of our net
borrowings.ü
    
    General and administrative
expenses decreased by $0.8 million
between first and second half of 2006 as
a result of various cost saving
initiatives undertaken by the refinery
management team and a decrease in legal
costs as a result of the settlement of
our dispute with Clough Niugini Limited
at the end of the first half of 2006.ü
    
    Depreciation increased by $0.3
million as a direct result of the
capital revamp works undertaken during
the year.
   ü
    
    Contract premium
improvements to export
productsü
    
    Improvement to negotiated
foreign exchange rates on PGK and
USD transactionsü
    
    Improvement to working capital interest ratesü
    
    Improved product yieldsü
    
    Decreased fuel costs
  ü
    
    Conduct
negotiations to reduce
working capital costsü
    
    Implement strategies to
further improve foreign
exchange ratesü
    
    Reduce direct operating costsü
    
    Eliminate unplanned downtimeü
    
    Expand niche market for InterOil Power Fuelü
    
    Reduce length of working capital cycleü
    
    Seek out and exploit
operational and tax planning
synergies in conjunction with
the newly expanded downstream
business
 
 INTEROIL 2006      44




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##### Table of Contents



MidstreamRefining and Marketing  Operating results
    
    Years ended December 31,($ thousands)
    
    2006
    
    2005(2)
    
    2004(1),(2)External sales
    
    
    315,211
    
    
    
    356,327
    
    
    
    26,310Inter-segment revenue
    
    
    136,584
    
    
    
    80,094
    
    
    
    Interest and other revenue
    
    
    360
    
    
    
    245
    
    
    
    (55
    )Total segment revenue
    
    
    452,155
    
    
    
    436,666
    
    
    
    26,255Cost of sales and operating expenses
    
    
    (451,374
    )
    
    
    (436,491
    )
    
    
    (27,686
    )Office and administration and other expenses
    
    
    (10,577
    )
    
    
    (9,747
    )
    
    
    (3,189
    )Gain on derivative contracts
    
    
    2,560
    
    
    
    542
    
    
    
    34Foreign exchange gain/(loss)
    
    
    4,636
    
    
    
    (1,434
    )
    
    
    22Earnings before interest, taxes, depreciation
and amortization (unaudited)
    
    
    (2,600
    )
    
    
    (10,464
    )
    
    
    (4,563
    )Depreciation and amortization
    
    
    (10,729
    )
    
    
    (10,598
    )
    
    
    (312
    )Interest expense
    
    
    (10,881
    )
    
    
    (10,162
    )
    
    
    (844
    )Loss from ordinary activities before income taxes
    
    
    (24,210
    )
    
    
    (31,224
    )
    
    
    (5,719
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    Non controlling interest
    
    
    259
    
    
    
    362
    
    
    
    69Total net loss
    
    
    (23,951
    )
    
    
    (30,862
    )
    
    
    (5,650
    )
 
 (1)
    
    Our refinery began
commercial operations on January 1, 2005.
During 2004 we were still constructing and
commissioning our refinery and the costs
associated with the construction and
commissioning of our refinery were
capitalized rather than expensed. As a
result of our refinery not having any
commercial operations in 2004, our 2004 to
2005 and 2006 results are not comparable.(2)
    
    Our 2005 and 2004 segment
results have been represented to confirm
with the presentation adopted in 2006.
Previously, interest revenue and
non-controlling interest were allocated to
the corporate segment. Amounts associated
with these line items are now included in
each operating segments result.   ü
    
    An increase to gross margin of
$0.5 million for the year was primarily
the result of the revamp improvements
made in the second half of 2006 and
price risk management activities over
the year.ü
    
    Higher office and
administration and other expenses of
$0.8 million was due to a number of
factors including increased repairs
and maintenance, corporate
allocations, travel costs, and
management salaries and contractor
costs.ü
    
    An increase to the gain on
derivative contracts of $2.0
million due to increased price risk
management activity that is deemed
not to be subject to hedge
accounting.ü
    
    An increase in foreign exchange
gain/(loss) of $6.1 million was due to
the strengthening of the PGK against USD
and negotiating improved rates on our
PGK to USD transactions during 2006.
 45 INTEROIL 2006




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##### Table of Contents



ü
    
    Higher depreciation expense of
$0.1 million was due to the addition
of depreciable assets from the
refinery revamp program.
 ü
    
    An increase in interest expense
of $0.7 million was due to increasing
LIBOR rates and increased borrowing
requirements due to higher oil prices
partially offset by a decrease in line
of credit (LC) fees.
  Q:
    
    What type of liquefaction
facility does InterOil currently
envisage?
 A:
    
    A facility that will produce 9
million tons per annum of liquefied
natural gas
     MidstreamLiquefaction Operating results
    
    Years ended December 31,($ thousands)
    
    2006
    
    2005(1)
    
    2004(1)External sales
    
    
    
    
    
    
    
    
    
    
    Inter-segment revenue
    
    
    
    
    
    
    
    
    
    
    Total segment revenue
    
    
    
    
    
    
    
    
    
    
    Cost of sales and
operating expenses
    
    
    
    
    
    
    
    
    
    
    Office and
administration and other expenses
    
    
    (694
    )
    
    
    
    
    
    
    Earnings before
interest, taxes,
depreciation and
amortization
(unaudited)
    
    
    (694
    )
    
    
    
    
    
    
    Depreciation and
amortization
    
    
    
    
    
    
    
    
    
    
    Interest expense
    
    
    
    
    
    
    
    
    
    
    Loss from ordinary
activities before
income taxes
    
    
    (694
    )
    
    
    
    
    
    
    Income tax expense
    
    
    
    
    
    
    
    
    
    
    Total net loss
    
    
    (694
    )
    
    
    
    
    
    
    
 
 (1)
    
    Our liquefaction segment was
formed in 2006 and as a result
there is no comparative
information for 2005 and 2004.
The liquefaction segment is in
its early stage of development.   INTEROIL 2006      46




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##### Table of Contents



Q:
    How prominent is InterOils
wholesale and retail distribution
business in Papua New Guinea.
 A:
    The InterOil name is associated with
49 service stations, 11 depots and 6
terminals. InterOil supplies 67% of Papua New
Guineas refined petroleum product
needs.
   Key Downstream Metrics
    
    2006
    
    2005Net income ($ millions)
    
    $
    3.0
    
    
    $
    6.4EBITDA ($ millions)
    
    $
    6.3
    
    
    $
    9.6Market share (1)
    
    
    67
    %
    
    
    29
    %Sales volumes (millions of liters) (2)
    
    
    291.8
    
    
    
    210.4Cost of distribution per liter
($  per liter) (3)
    
    $
    0.06
    
    
    $
    0.05
 
 (1)
    
    Market share has been
calculated based on domestic purchases of
product from the refinery during the
final quarter of each year.(2)
    
    Sales volumes reflect the
actual sales volumes achieved for the
year and therefore only include the
effect of the Shell acquisition from
October 1, 2006.(3)
    
    Cost of distribution per
liter includes land based freight costs
and operational costs. It excludes
depreciation and interest.   47      INTEROIL 2006




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INTEROIL 2006      48




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49      INTEROIL 2006




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Downstream  Operating results
    
    Years ended December 31,($ thousands)
    
    2006(1)
    
    2005(2)
    
    2004(2),(3)External sales
    
    
    195,877
    
    
    
    124,854
    
    
    
    62,410Inter-segment revenue
    
    
    22
    
    
    
    6
    
    
    
    489Interest and other revenue
    
    
    1,421
    
    
    
    341
    
    
    
    263Total segment revenue
    
    
    197,320
    
    
    
    125,201
    
    
    
    63,162Cost of sales and operating expenses
    
    
    
    
    
    
    
    
    
    
    (53,159
    )Office and administration and other expenses
    
    
    (7,479
    )
    
    
    (4,725
    )
    
    
    (3,147
    )Earnings before interest, taxes, depreciation and
amortization (unaudited)
    
    
    6,330
    
    
    
    9,619
    
    
    
    6,856Depreciation and amortization
    
    
    (910
    )
    
    
    (204
    )
    
    
    (224
    )Interest expense
    
    
    (152
    )
    
    
    (226
    )
    
    
    (455
    )Income from ordinary activities before income taxes
    
    
    5,268
    
    
    
    9,189
    
    
    
    6,177Income tax expenses
    
    
    (2,273
    )
    
    
    (2,756
    )
    
    
    (1,900
    )Total net income
    
    
    2,995
    
    
    
    6,433
    
    
    
    4,277
 
 (1)
    
    Our wholesale and retail
distribution business segment acquired the
business of Shell Papua New Guinea Limited
on October 1, 2006 and contains the results
of the Shell business from this date.(2)
    
    Our 2005 and 2004 segment
results have been represented to confirm
with the presentation adopted in 2006.
Previously, interest revenue and
non-controlling interest were allocated to
the corporate segment. Amounts associated
with these line items are now included in
each operating segments result.(3)
    
    Our wholesale and retail
distribution business segment was acquired
on April 28, 2004 and only operated for
eight months during 2004. As a result of our
downstream results not having a full year of
operations in 2004, our 2004 to 2005 and
2006 results are not comparable.    ü
    
    A decrease to gross margin of
$1.6 million for the year 2006 over
the year 2005 was most significantly
the result of continuous drops in IPP
over the fourth quarter of 2006.The IPP dropped from K1.65 in September to
K1.49 at the beginning of January 2007. As
the IPP declined each month, any inventory
holdings purchased in preceding periods
were sold at lower IPP prices, resulting
in lower margins. The effect of this was
compounded as our acquisition of Shell and
its corresponding inventory balance
coincided with the decline in IPP pricing.ü
    
    An increase in office and
administration and other expenses of
$2.8 million due to a number of factors
including, higher insurance costs as a
result of the acquisition of the Shell
business and expansion of the aviation
business, higher corporate allocations,
increased repairs and maintenance costs,
and increased travel costs.ü
    
    An increase in depreciation
expense of $0.7 million over 2005
related primarily to the addition of the
Shell assets on October 1 and the
completion of the 2 million litre East
Sepik tank project.
 INTEROIL 2006      50




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##### Table of Contents



ü
    
    Our income tax expense as a
percentage of income from ordinary
activities has increased during 2006 as
the result of a reduction to the future
income tax benefit being recognized on
the revaluation of the Shell plant and
equipment acquired on October 1.
   ü
    
    Upgrades to
terminal, depots and
aviation sites
 ü
    
    Aviation upgrade and refueller vehicles
 ü
    
    New customer base pumps
and tankage requirements
 ü
    
    Finance system software installation
  ü
    
    Consider
commercial bunkering
opportunities
 ü
    
    Secure contracts to
supply new mining and
petroleum companies
 ü
    
    Pursue opportunities in
organic growth agriculture
sector
 ü
    
    Explore market
opportunities in North
Solomons Province, including
strategic alliances with key
distributors
 
 
 51 INTEROIL 2006




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##### Table of Contents



Corporate  Operating results
    
    Years ended December 31,($ thousands)
    
    2006(5)
    
    2005
    
    2004External sales elimination
    
    
    
    
    
    
    
    
    
    
    (18,075
    )Inter-segment revenue elimination(1)
    
    
    (136,606
    )
    
    
    (80,101
    )
    
    
    (489
    )Interest revenue
    
    
    (58
    )
    
    
    480
    
    
    
    165Other unallocated revenue
    
    
    
    
    
    
    (1
    )
    
    
    91Total segment revenue
    
    
    (136,664
    )
    
    
    (79,622
    )
    
    
    (18,306
    )Cost of sales and operating expenses elimination(1)
    
    
    135,391
    
    
    
    80,101
    
    
    
    15,500Office and administration and other expenses(2)
    
    
    (6,567
    )
    
    
    (6,193
    )
    
    
    (6,773
    )Earnings before interest, taxes, depreciation and
amortization (unaudited)
    
    
    (7,840
    )
    
    
    (5,714
    )
    
    
    (9,581
    )Depreciation and amortization(3)
    
    
    92
    
    
    
    79
    
    
    
    (90
    )Interest expense(4)
    
    
    (6,235
    )
    
    
    (599
    )
    
    
    (1,899
    )Income from ordinary activities before income taxes
    
    
    (13,983
    )
    
    
    (6,234
    )
    
    
    (11,570
    )Income tax expenses
    
    
    (69
    )
    
    
    (76
    )
    
    
    25Non-controlling interest
    
    
    4
    
    
    
    6
    
    
    
    1Total net income
    
    
    (14,048
    )
    
    
    (6,304
    )
    
    
    (11,544
    )
 
 (1)
    
    Represents the
elimination upon consolidation of our
refinery sales to other segments and
other minor inter-company product sales.(2)
    
    Includes the elimination of
inter-segment administration service fees.(3)
    
    Represents the amortization of a portion of costs capitalized to assets on
consolidation.(4)
    
    Includes the elimination of interest accrued between segments.(5)
    
    Our 2005 and 2004 segment
results have been represented to confirm
with the presentation adopted in 2006.
Previously, interest revenue and
non-controlling interest were allocated to
the corporate segment. Amounts associated
with these line items are now included in
each operating segments result.   ü
    
    A decrease of $0.3 million in
stock compensation expense recognized
in office and administration and
other expenses.
 ü
    
    An increase in interest expense
of $5.6 million primarily relating to
the increased borrowings made under
the secured loan facility entered into
in May 2006.
 INTEROIL 2006      52




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Net cash inflows/(outflows) from:
 ($ thousands)
    
    2006
    
    2005
    
    2004Operations
    
    
    (3,246
    )
    
    
    (22,713
    )
    
    
    (79,767
    )Investing
    
    
    (91,638
    )
    
    
    15,468
    
    
    
    (29,024
    )Financing
    
    
    66,964
    
    
    
    38,302
    
    
    
    128,119Net cash movement
    
    
    (27,920
    )
    
    
    31,057
    
    
    
    19,328Opening cash
    
    
    59,601
    
    
    
    28,544
    
    
    
    9,216Closing cash
    
    
    31,681
    
    
    
    59,601
    
    
    
    28,544
   ü
    
    Our cash used in operations,
prior to changes in non-cash working
capital increased, by $6.2 million.
This is primarily due to interest
paid on the $130.0 million secured
loan facility entered into in 2006.
 ü
    
    Our non-cash working capital
provided a cash inflow from operations
of $21 million in 2006 as compared to
contributing $4.7 million to the cash
outflows in 2005. This change of $25.7
million is primarily attributable to an
increase in our accounts payable,
accrued liabilities and income tax
payable creating a cash inflow of $25.0
million, $19.2 million relating to
movements in our inventories and an
offsetting $19.2 million as a result of
an increase in trade receivables.
   ü
    
    $15.9 million increase in our
secured cash balances in 2006 versus an
increase of $1.1 million in 2005.
 ü
    
    $25.8 million, net of cash
received, used to acquire Shell Papua
New Guinea on October 1.
 ü
    
    $42.6 million on oil and gas
exploration expenditure in 2006 versus
$43.0 million in 2005 mainly related
to drilling and seismic activities.
 ü
    
    $13.6 million on plant and
equipment in 2006 versus $5.6 million in
2005 which is primarily related to the
revamp and optimization activities
undertaken by the refinery and the
additional diesel tank built by the
downstream business in East Sepik.
    ü
    
    $125.3 million of net proceeds
from our secured loan facility
entered into in May 2006.
 ü
    
    $1.5 million from the
issuance of common shares in 2006
as compared to $5.5 million
received in 2005.
 ü
    
    $33.9 million of repayments on the
crude import facility in 2006 versus
$5.8 million of repayments made in the
2005 period.
 ü
    
    $21.5 million in repayments of
unsecured loans in 2006. These proceeds
were received in 2005.
 53      INTEROIL 2006




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##### Table of Contents



ü
    
    $33.1 million for the drilling and
testing of the Elk-1 exploration well.
The Elk-1 well expenditures were higher
than expected as a result of
encountering high pressure gas that
required significant expenditures to
control the well pressure before we
could continue drilling the well. Our
drilling progress was impeded for three
months.
 ü
    
    $3.0 million of pre-drill costs on
the Elk-2 structure, including site
preparation, camp construction, rig
mobilization and supplier standby
costs.
 ü
    
    $1.0 million of demobilization
costs from the Triceratops drill
site.
 ü
    
    $5.6 million for seismic acquisition.ü
    
    $1.1 million for airborne gravity survey work.
 ü
    
    $3.8 million for rig
equipment, primarily in relation to
increasing the capacity of the mud
circulation system.
 ü
    
    $0.6 million for inventory and
other costs includes drilling
consumables such as mud, casing and
drill bits, as well as spare parts for
all the rig equipment.
 ü
    
    $0.3 million of pre-drill costs
for the Antelope-1 well which includes
preliminary site clearing and the
construction of a helicopter pad. We
anticipate mobilizing to Antelope-1
wellsite immediately after rig release
from Elk-2 well.
          INTEROIL 2006      54




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55      INTEROIL 2006




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INTEROIL 2006      56




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Payments Due by Period
 Contractual obligations
    
    Total
    
    Less than
    
    1  2
    
    2  3
    
    3  4
    
    4  5
    
    More than($ thousands)
    
    
    
    
    
    1 year
    
    years
    
    years
    
    years
    
    years
    
    5 yearsSecured loan obligations
    
    
    197,666
    
    
    
    13,500
    
    
    
    130,666
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    26,500Accrued financing costs
    
    
    1,450
    
    
    
    363
    
    
    
    1,087
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Acquisition of subsidiary
    
    
    1,771
    
    
    
    1,771
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Indirect participation
interest(1)
    
    
    1,744
    
    
    
    731
    
    
    
    1,031
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Indirect participation
interest(2)
    
    
    49,289
    
    
    
    12,461
    
    
    
    21,087
    
    
    
    15,740
    
    
    
    
    
    
    
    
    
    
    
    Petroleum prospecting and
retention licenses(3)
    
    
    5,237
    
    
    
    1,877
    
    
    
    3,360
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    257,157
    
    
    
    30,703
    
    
    
    157,213
    
    
    
    24,740
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    26,500
 
 (1)
    
    These amounts represent the
estimated cost of completing our commitment
to drill exploration wells under our
indirect participation interest agreement
entered into in July 2003. See Note 18 to
our unaudited financial statements for the
years ended December 31, 2006, 2005 and
2004.(2)
    
    These amounts represent the estimated
cost of completing our commitment to drill
exploration wells under our indirect
participation interest agreement entered
into in February 2005. See Note 18 to our
unaudited financial statements for the the
years ended December 31, 2006, 2005 and
2004.(3)
    
    The amount pertaining to the petroleum
prospecting and retention licenses
represents the amount InterOil has committed
to spend to its joint venture partners. In
addition to this amount, InterOil must drill
an exploration well in Petroleum Prospecting
License 237 prior to the end of March 2009
in order to retain this license. As the cost
of drilling this well cannot be estimated,
it is not included within the above table.       57       INTEROIL 2006




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##### Table of Contents



Share Capital
    
    Number of sharesBalance December 31, 2005
    
    
    29,163,320Shares issued on exercise of
options
    
    
    132,285Shares issued on amendment
of indirect participation interest (PNGDV)
    
    
    575,575Balance December 31, 2006
    
    
    29,871,180Shares issued on exercise
of optionsShares issued on conversion of
indirect participation interest
    
    
    26,667Balance February 28, 2007
    
    
    29,897,847Remaining stock options
authorized
    
    
    1,026,000Remaining shares issuable
upon exercise of warrants
    
    
    340,247Remaining conversion rights
authorized(1)
    
    
    3,306,667Other
    
    
    5,000Balance February 28, 2007
(Diluted)
    
    
    34,575,761
 (1)
    In 2005, we sold indirect
participation working interests in our
exploration program. Some of the investors
under our indirect participation interest
agreement entered into in February 2005 have
the right to convert, under certain
circumstances, their interest to our common
shares. If 100% of the investors under our
indirect participation interest agreement
choose to convert their interests, we would
be required to issue an additional 3,306,667
common shares.      INTEROIL 2006 58




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59 INTEROIL 2006




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INTEROIL 2006 60




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61 INTEROIL 2006




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
    
    Section 1530, Comprehensive Income;
    
    Section 3855, Financial Instruments  Recognition and Measurement; and
    
    Section 3865, Hedges.
     Section 1530, Comprehensive Income:
  Statement of Comprehensive Income
    
    Years ended December 31,($ thousands)
    
    2006
    
    
    2005
    
    
    2004Net Loss
    
    
    (43,386
    )
    
    
    (39,282
    )
    
    
    (52,940
    )Foreign currency
translation reserve, net of tax
    
    
    1,019
    
    
    
    14
    
    
    
    463Deferred hedge
gain, net of tax
    
    
    
    
    
    
    
    
    
    
    Other
Comprehensive Income
    
    
    1,019
    
    
    
    14
    
    
    
    463Comprehensive Income
    
    
    (42,367
    )
    
    
    (39,268
    )
    
    
    (52,477
    )
  Section 3855, Financial Instruments  Recognition and Measurement:
  INTEROIL 2006 62




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Section 3865, Hedges:
  
    63 INTEROIL 2006




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##### Table of Contents



Quarters ended
    
    2006(2),(3)
    
    2005 (adjusted)(1),(2)($ thousands) (unaudited)
    
    Dec 31
    
    Sep 30
    
    Jun 30
    
    Mar 31
    
    Dec 31
    
    Sep 30
    
    Jun 30
    
    Mar 31Earnings before interest, taxes,
depreciation and amortization
    
    
    6,541
    
    
    
    1,140
    
    
    
    (10,257
    )
    
    
    (9,105
    )
    
    
    (5,566
    )
    
    
    3,486
    
    
    
    (6,856
    )
    
    
    (5,858
    )Upstream
    
    
    (1,051
    )
    
    
    (1,337
    )
    
    
    (2,262
    )
    
    
    (2,227
    )
    
    
    (2,362
    )
    
    
    (1,655
    )
    
    
    (2,615
    )
    
    
    (1,603
    )Midstream  Refining and Marketing
    
    
    9,144
    
    
    
    1,674
    
    
    
    (8,188
    )
    
    
    (5,230
    )
    
    
    (6,333
    )
    
    
    6,070
    
    
    
    (6,796
    )
    
    
    (3,405
    )Midstream  Liquefaction
    
    
    (396
    )
    
    
    (298
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    1,143
    
    
    
    1,954
    
    
    
    3,559
    
    
    
    (326
    )
    
    
    3,963
    
    
    
    2,522
    
    
    
    2,550
    
    
    
    584Corporate & Consolidated
    
    
    (2,299
    )
    
    
    (853
    )
    
    
    (3,366
    )
    
    
    (1,322
    )
    
    
    (834
    )
    
    
    (3,451
    )
    
    
    5
    
    
    
    (1,434
    )Subtract:Interest expense
    
    
    5,649
    
    
    
    5,349
    
    
    
    3,609
    
    
    
    2,666
    
    
    
    2,989
    
    
    
    2,455
    
    
    
    2,996
    
    
    
    2,547Upstream
    
    
    2
    
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    (6
    )
    
    
    2
    
    
    
    2
    
    
    
    2Midstream  Refining and Marketing
    
    
    2,479
    
    
    
    3,329
    
    
    
    2,731
    
    
    
    2,342
    
    
    
    2,756
    
    
    
    2,320
    
    
    
    2,735
    
    
    
    2,351Midstream  Liquefaction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    37
    
    
    
    38
    
    
    
    39
    
    
    
    38
    
    
    
    44
    
    
    
    42
    
    
    
    140
    
    
    
    Corporate & Consolidated
    
    
    3,131
    
    
    
    1,981
    
    
    
    838
    
    
    
    285
    
    
    
    195
    
    
    
    91
    
    
    
    119
    
    
    
    194Income taxes &
non-controlling interest
    
    
    1,049
    
    
    
    244
    
    
    
    1,031
    
    
    
    (245
    )
    
    
    910
    
    
    
    1,000
    
    
    
    301
    
    
    
    253Upstream
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Midstream  Refining and Marketing
    
    
    42
    
    
    
    (46
    )
    
    
    (137
    )
    
    
    (118
    )
    
    
    (129
    )
    
    
    19
    
    
    
    (333
    )
    
    
    81Midstream  Liquefaction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    996
    
    
    
    416
    
    
    
    1,005
    
    
    
    (144
    )
    
    
    1,062
    
    
    
    965
    
    
    
    570
    
    
    
    159Corporate & Consolidated
    
    
    11
    
    
    
    (126
    )
    
    
    163
    
    
    
    17
    
    
    
    (23
    )
    
    
    16
    
    
    
    64
    
    
    
    13Depreciation & amortization
    
    
    3,554
    
    
    
    3,100
    
    
    
    2,862
    
    
    
    2,837
    
    
    
    2,700
    
    
    
    2,943
    
    
    
    2,699
    
    
    
    2,695Upstream
    
    
    233
    
    
    
    202
    
    
    
    173
    
    
    
    198
    
    
    
    96
    
    
    
    213
    
    
    
    2
    
    
    
    3Midstream  Refining and Marketing
    
    
    2,805
    
    
    
    2,700
    
    
    
    2,626
    
    
    
    2,598
    
    
    
    2,662
    
    
    
    2,663
    
    
    
    2,641
    
    
    
    2,632Midstream  Liquefaction
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    537
    
    
    
    222
    
    
    
    89
    
    
    
    62
    
    
    
    55
    
    
    
    55
    
    
    
    51
    
    
    
    43Corporate & Consolidated
    
    
    (21
    )
    
    
    (24
    )
    
    
    (26
    )
    
    
    (21
    )
    
    
    (113
    )
    
    
    12
    
    
    
    5
    
    
    
    17Net income (loss) per segment(1)
    
    
    (3,711
    )
    
    
    (7,553
    )
    
    
    (17,759
    )
    
    
    (14,363
    )
    
    
    (12,165
    )
    
    
    (2,912
    )
    
    
    (12,852
    )
    
    
    (11,353
    )Upstream
    
    
    (1,286
    )
    
    
    (1,540
    )
    
    
    (2,436
    )
    
    
    (2,426
    )
    
    
    (2,452
    )
    
    
    (1,870
    )
    
    
    (2,619
    )
    
    
    (1,608
    )Midstream  Refining and Marketing
    
    
    3,818
    
    
    
    (4,309
    )
    
    
    (13,408
    )
    
    
    (10,052
    )
    
    
    (11,622
    )
    
    
    1,068
    
    
    
    (11,839
    )
    
    
    (8,469
    )Midstream  Liquefaction
    
    
    (396
    )
    
    
    (298
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Downstream
    
    
    (427
    )
    
    
    1,278
    
    
    
    2,426
    
    
    
    (282
    )
    
    
    2,802
    
    
    
    1,460
    
    
    
    1,789
    
    
    
    382Corporate & Consolidated
    
    
    (5,420
    )
    
    
    (2,684
    )
    
    
    (4,341
    )
    
    
    (1,603
    )
    
    
    (893
    )
    
    
    (3,570
    )
    
    
    (183
    )
    
    
    (1,658
    )
 INTEROIL 2006       64




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##### Table of Contents



(1)
    
    Comparative quarterly results for all quarters during 2005 have been adjusted and
re-presented to include the adopted accounting treatment for exploration expenses associated
with our $125 million Indirect Participation Interest Agreement entered into in February 2005
as reviewed by our auditors in the third quarter of 2005. The adjusted results present the
quarterly financial information as if the indirect participation interest accounting policy
we adopted during the third quarter of 2005 had been adopted at the inception of the
agreement. See Note 23 to our unaudited financial statements for the three and nine month
periods ended September 30, 2006 and 2005.(2)
    
    Our comparative quarterly results for all quarters during 2005 and 2006 have been represented
to conform with the presentation adopted at December 31, 2006. Previously, interest revenue
and non-controlling interest were allocated to the corporate segment. Amounts associated with
these line items are now included in each operating segments result.(3)
    
    Our September 2006 quarterly results have been represented to separate out our
Midstream-Liquefaction segment from the Midstream Refining and Marketing segment.
     
 65       INTEROIL 2006




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INTEROIL 2006       66




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67
    
    INTEROILANNUAL REPORT 2006




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##### Table of Contents



INTEROIL 2006       68




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##### Table of Contents



As atDecember 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $AssetsCurrent assets:Cash and cash equivalents (note 5)
    
    
    31,681,435
    
    
    
    59,601,807
    
    
    
    28,544,398Cash restricted (note 7)
    
    
    29,301,940
    
    
    
    16,452,216
    
    
    
    15,497,127Trade receivables (note 8)
    
    
    67,542,902
    
    
    
    49,958,973
    
    
    
    58,698,069Commodity derivative contracts (note 7)
    
    
    1,759,575
    
    
    
    1,482,798
    
    
    
    503,500Other assets
    
    
    2,954,946
    
    
    
    1,011,195
    
    
    
    806,123Inventories (note 9)
    
    
    67,593,558
    
    
    
    44,087,484
    
    
    
    27,916,902Prepaid expenses
    
    
    880,640
    
    
    
    638,216
    
    
    
    190,135Assets held for sale (note 10)
    
    
    
    
    
    
    
    
    
    
    Total current assets
    
    
    201,714,996
    
    
    
    173,232,689
    
    
    
    132,156,254Cash restricted (note 7)
    
    
    3,217,284
    
    
    
    210,053
    
    
    
    102,096Deferred financing costs (note 17)
    
    
    1,716,757
    
    
    
    1,256,816
    
    
    
    1,311,488Plant and equipment (note 10)
    
    
    242,642,077
    
    
    
    237,399,148
    
    
    
    244,363,355Oil and gas properties (note 11)
    
    
    37,449,734
    
    
    
    16,399,492
    
    
    
    6,605,360Future income tax benefit (note 12)
    
    
    1,424,014
    
    
    
    1,058,898
    
    
    
    1,303,631Total assets
    
    
    488,164,862
    
    
    
    429,557,096
    
    
    
    385,842,184Liabilities and shareholders equityCurrent liabilities:Accounts payable and accrued liabilities
    
    
    73,310,793
    
    
    
    26,005,034
    
    
    
    26,328,544Income tax payable
    
    
    2,784,576
    
    
    
    3,900,459
    
    
    
    2,881,398Commodity derivative contracts (note 6)
    
    
    
    
    
    
    Working capital facility  crude feedstock (note 13)
    
    
    36,873,508
    
    
    
    70,724,322
    
    
    
    76,520,541Deferred hedge gain (note 7)
    
    
    1,385
    
    
    
    1,016,998
    
    
    
    537,358Business combination financing (note 14)
    
    
    
    
    
    
    
    
    
    
    12,123,106Unsecured loan (note 16)
    
    
    
    
    
    
    21,453,132
    
    
    
    Due to related parties (note 15)
    
    
    
    
    
    
    
    
    
    
    1,056,251Deferred liquefaction project liability (note 17)
    
    
    6,553,080
    
    
    
    
    
    
    
    Current portion of secured loan (note 17)
    
    
    13,500,000
    
    
    
    9,000,000
    
    
    
    9,000,000Current portion of indirect participation interest
- PNGDV (note 18)
    
    
    730,534
    
    
    
    
    
    
    
    Current portion of indirect participation interest
(note 18)
    
    
    12,460,725
    
    
    
    35,092,558
    
    
    
    13,749,852Total current liabilities
    
    
    146,214,601
    
    
    
    167,192,503
    
    
    
    142,197,050Accrued financing costs (note 17)
    
    
    1,087,500
    
    
    
    921,109
    
    
    
    863,329Secured loan (note 17)
    
    
    184,166,433
    
    
    
    71,500,000
    
    
    
    76,000,000Indirect participation interest (note 18)
    
    
    36,827,877
    
    
    
    30,166,311
    
    
    
    Indirect participation interest  PNGDV (note 18)
    
    
    1,012,999
    
    
    
    9,685,830
    
    
    
    10,608,830Total liabilities
    
    
    369,309,410
    
    
    
    279,465,753
    
    
    
    229,669,209Non-controlling interest (note 19)
    
    
    5,759,206
    
    
    
    6,023,149
    
    
    
    6,404,262Shareholders equity:Share capital (note 20)
    
    
    233,889,366
    
    
    
    223,934,500
    
    
    
    216,813,654Authorised  unlimitedIssued and outstanding - 29,871,180(Dec 31, 2005 - 29,163,320)(Dec 31, 2004 - 28,310,884)Contributed surplus
    
    
    4,377,426
    
    
    
    2,933,586
    
    
    
    1,841,776Warrants (note 22)
    
    
    2,137,852
    
    
    
    2,137,852
    
    
    
    2,258,227Foreign currency translation adjustment
    
    
    1,492,869
    
    
    
    477,443
    
    
    
    463,200Conversion options (note 18)
    
    
    25,475,368
    
    
    
    25,475,368
    
    
    
    Accumulated deficit
    
    
    (154,276,635
    )
    
    
    (110,890,555
    )
    
    
    (71,608,144
    )Total shareholders equity
    
    
    113,096,246
    
    
    
    144,068,194
    
    
    
    149,768,713Total liabilities and shareholders equity
    
    
    488,164,862
    
    
    
    429,557,096
    
    
    
    385,842,184
 See accompanying notes to the consolidated financial statements. Commitments and contingencies (note 24).
On behalf of the Board  Phil Mulacek, Director; Christian Vinson, Director.
 69
    
    INTEROILANNUAL REPORT 2006




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $RevenueSales and operating revenues
    
    
    511,087,934
    
    
    
    481,180,645
    
    
    
    70,644,486Interest
    
    
    3,223,995
    
    
    
    1,830,808
    
    
    
    382,461Other
    
    
    3,747,603
    
    
    
    528,270
    
    
    
    196,337518,059,532
    
    
    
    483,539,723
    
    
    
    71,223,284ExpensesCost of sales and operating expenses
    
    
    499,494,540
    
    
    
    467,246,990
    
    
    
    65,344,516Administrative and general expenses
    
    
    20,728,618
    
    
    
    14,672,793
    
    
    
    7,831,550Depreciation and amortization
    
    
    12,352,672
    
    
    
    11,036,550
    
    
    
    639,075Exploration costs, excluding exploration
impairment (note 11)
    
    
    1,657,671
    
    
    
    
    
    
    
    2,903,313Exploration impairment (note 11)
    
    
    416,923
    
    
    
    2,144,429
    
    
    
    35,566,761Legal and professional fees
    
    
    3,937,517
    
    
    
    3,606,415
    
    
    
    3,573,727Short term borrowing costs
    
    
    8,478,540
    
    
    
    8,855,857
    
    
    
    4,705,190Long term borrowing costs
    
    
    11,856,872
    
    
    
    6,351,337
    
    
    
    1,401,256Accretion expense (note 18)
    
    
    3,741,254
    
    
    
    5,647,491
    
    
    
    Loss on amendment of indirect participation
interest  PNGDV (note 18)
    
    
    1,446,901
    
    
    
    
    
    
    
    Foreign exchange loss/(gain)
    
    
    (4,744,810
    )
    
    
    796,590
    
    
    
    392,805559,366,698
    
    
    
    520,358,452
    
    
    
    122,358,193Loss before income taxes and non-controlling interest
    
    
    (41,307,166
    )
    
    
    (36,818,729
    )
    
    
    (51,134,909
    )Income taxesCurrent
    
    
    (1,232,487
    )
    
    
    (2,605,265
    )
    
    
    (2,538,410
    )Future
    
    
    (1,110,386
    )
    
    
    (226,729
    )
    
    
    663,347(2,342,873
    )
    
    
    (2,831,994
    )
    
    
    (1,875,063
    )Loss before non-controlling interest
    
    
    (43,650,039
    )
    
    
    (39,650,723
    )
    
    
    (53,009,972
    )Non-controlling interest (note 16)
    
    
    263,959
    
    
    
    368,312
    
    
    
    70,091Net loss
    
    
    (43,386,080
    )
    
    
    (39,282,411
    )
    
    
    (52,939,881
    )Basic loss per share (note 20)
    
    
    (1.47
    )
    
    
    (1.36
    )
    
    
    (2.09
    )Diluted loss per share (note 20)
    
    
    (1.47
    )
    
    
    (1.36
    )
    
    
    (2.09
    )Weighted average number of common
shares outstandingBasic and diluted
    
    
    29,602,360
    
    
    
    28,832,263
    
    
    
    25,373,575
 See accompanying notes to the consolidated financial statements.
 INTEROIL 2006       70




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Cash flows provided by (used in):Operating activitiesNet (loss) (note 5)
    
    
    (43,386,080
    )
    
    
    (39,282,411
    )
    
    
    (52,939,881
    )Adjustments for non-cash transactionsNon-controlling interest
    
    
    (263,959
    )
    
    
    (381,113
    )
    
    
    (70,091
    )Depreciation and amortization
    
    
    12,352,672
    
    
    
    11,036,550
    
    
    
    639,075Future income tax asset
    
    
    1,333,108
    
    
    
    244,733
    
    
    
    (663,347
    )Loss/(gain) on sale of other assets
    
    
    
    
    
    
    
    
    
    
    (94,260
    )Loss/(gain) on sale of plant and equipment
    
    
    263,945
    
    
    
    (95,053
    )
    
    
    Impairment of plant and equipment
    
    
    755,857
    
    
    
    
    
    
    
    Amortization of discount on debt
    
    
    28,891
    
    
    
    161,255
    
    
    
    604,045Amortization of deferred financing costs
    
    
    219,033
    
    
    
    154,672
    
    
    
    268,873Accretion of discount on indirect participation
interest
    
    
    3,741,254
    
    
    
    5,647,491
    
    
    
    Debt conversion settlement expense  debentures
(note 22)
    
    
    
    
    
    
    
    
    
    
    77,589Interest expense forfeited by debenture holders
    
    
    
    
    
    
    
    
    
    
    998,438Loss/(gain) on unsettled hedge contracts
    
    
    (71,875
    )
    
    
    119,200
    
    
    
    33,858Gain on derivative contracts
    
    
    (1,220,500
    )
    
    
    (585,000
    )
    
    
    Stock compensation expense
    
    
    1,976,072
    
    
    
    1,668,896
    
    
    
    1,209,921Inventory revaluation
    
    
    
    
    
    
    355,215
    
    
    
    1,508,334Capitalized oil and gas properties expensed
    
    
    416,923
    
    
    
    2,144,429
    
    
    
    35,566,761Loss on amendment of indirect participation
interest  PNGDV
    
    
    1,446,901
    
    
    
    
    
    
    
    Unrealized foreign exchange loss/(gain)
    
    
    (4,744,810
    )
    
    
    796,590
    
    
    
    392,805Non-cash interest on secured loan facility
    
    
    2,926,025
    
    
    
    
    
    
    
    Change in non-cash operating working capitalIncrease in foreign currency translation
adjustment
    
    
    
    
    
    
    
    
    
    
    (Increase)/decrease in trade receivables
    
    
    (10,438,531
    )
    
    
    8,751,789
    
    
    
    (49,224,125
    )(Increase) in commodity derivative contracts
    
    
    
    
    
    
    (33,858
    )
    
    
    (Increase)/decrease in other assets and prepaid
expenses
    
    
    4,051
    
    
    
    (653,153
    )
    
    
    982,014Decrease/ (increase) in inventories
    
    
    2,642,493
    
    
    
    (16,515,467
    )
    
    
    (23,240,590
    )Increase in accounts payable, accrued liabilities
and income tax payable
    
    
    28,773,008
    
    
    
    3,752,531
    
    
    
    4,183,664(3,245,522
    )
    
    
    (22,712,704
    )
    
    
    (79,766,917
    )Investing activitiesExpenditure on oil and gas properties
    
    
    (21,405,742
    )
    
    
    (11,249,477
    )
    
    
    (19,154,106
    )Expenditure on plant and equipment
    
    
    (13,585,792
    )
    
    
    (5,575,194
    )
    
    
    (38,947,904
    )Proceeds from indirect participation interest
    
    
    
    
    
    
    80,410,591
    
    
    
    10,724,885Expenditure on oil and gas properties
applied against
indirect participation interest (note 18)
    
    
    (21,152,032
    )
    
    
    (31,774,513
    )
    
    
    Proceeds received on sale of assets
    
    
    3,770,080
    
    
    
    112,229
    
    
    
    405,353Redemption of short-term investments
    
    
    
    
    
    
    
    
    
    
    24,723,572Acquisition of subsidiary net of cash received
(note 14)
    
    
    (25,820,515
    )
    
    
    
    
    
    
    4,631,904Repayment of business combination financing
    
    
    
    
    
    
    (12,226,581
    )
    
    
    Deposit on business acquisition
    
    
    
    
    
    
    
    
    
    
    (Increase) in restricted cash held as security on
borrowings
    
    
    (15,856,955
    )
    
    
    (1,063,046
    )
    
    
    (15,501,806
    )Change in non-cash working capitalIncrease/(decrease) in accounts payable and
accrued liabilities
    
    
    2,412,621
    
    
    
    (3,165,756
    )
    
    
    4,094,594(91,638,335
    )
    
    
    15,468,253
    
    
    
    (29,023,508
    )
 71       INTEROIL 2006




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Financing activitiesProceeds from/(repayments of) unsecured loan
    
    
    
    
    
    
    
    
    
    
    Repayments of secured loan
    
    
    (4,500,000
    )
    
    
    (4,500,000
    )
    
    
    Proceeds from secured loan, net of transaction costs
    
    
    125,293,488
    
    
    
    
    
    
    
    2,000,000Net proceeds from senior convertible debentures
and warrants
    
    
    
    
    
    
    
    
    
    
    41,740,234Increase in deferred financing fees related to
secured loan
    
    
    
    
    
    
    
    
    
    
    Proceeds from conversion options
    
    
    
    
    
    
    22,700,814
    
    
    
    6,259,967Proceeds from related party borrowings
    
    
    
    
    
    
    
    
    
    
    1,775,565(Repayments) to related parties
    
    
    
    
    
    
    (1,056,251
    )
    
    
    (2,198,065
    )Proceeds from unsecured borrowings
    
    
    
    
    
    
    21,453,132
    
    
    
    5,100,000Repayments of unsecured borrowings
    
    
    (21,453,132
    )
    
    
    
    
    
    
    (5,100,000
    )Proceeds from/(repayments of) working
capital facility
    
    
    (33,850,814
    )
    
    
    (5,796,219
    )
    
    
    76,520,541Proceeds from issue of common shares
    
    
    1,473,943
    
    
    
    5,500,384
    
    
    
    2,020,31666,963,485
    
    
    
    38,301,860
    
    
    
    128,118,558Increase/(decrease) in cash and cash equivalents
    
    
    (27,920,372
    )
    
    
    31,057,409
    
    
    
    19,328,133Cash and cash equivalents, beginning of period
    
    
    59,601,807
    
    
    
    28,544,398
    
    
    
    9,216,265Cash and cash equivalents, end of period (note 5)
    
    
    31,681,435
    
    
    
    59,601,807
    
    
    
    28,544,398
 See accompanying notes to the consolidated financial statements.
 See note 5 for non cash financing and investing activities.
 
 INTEROIL 2006       72




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##### Table of Contents



Year endedDecember 31, 2006
    
    
    December 31, 2005
    
    
    December 31,2004$
    
    
    $
    
    
    $Share capitalAt beginning of period
    
    
    223,934,500
    
    
    
    216,813,654
    
    
    
    157,449,200Adjustment
to reflect change in accounting for employee stock options (note 2(t))
    
    
    
    
    
    
    
    
    
    
    92,434Issue of capital stock (note 20)
    
    
    9,954,866
    
    
    
    7,120,846
    
    
    
    59,272,020At end of period
    
    
    233,889,366
    
    
    
    223,934,500
    
    
    
    216,813,654Contributed surplusAt beginning of period
    
    
    2,933,586
    
    
    
    1,841,776
    
    
    
    540,222Adjustment to reflect change in accounting for
employee stock options (note 2(t))
    
    
    
    
    
    
    
    
    
    
    645,216Stock compensation (note 21)
    
    
    1,443,840
    
    
    
    1,091,810
    
    
    
    656,338At end of period
    
    
    4,377,426
    
    
    
    2,933,586
    
    
    
    1,841,776WarrantsAt beginning of period
    
    
    2,137,852
    
    
    
    2,258,227
    
    
    
    Movement for period (note 22)
    
    
    
    
    
    
    (120,375
    )
    
    
    2,258,227At end of period
    
    
    2,137,852
    
    
    
    2,137,852
    
    
    
    2,258,227Foreign currency translation adjustmentAt beginning of period
    
    
    477,443
    
    
    
    463,200
    
    
    
    Movement for period, net of tax
    
    
    1,015,426
    
    
    
    14,243
    
    
    
    463,200At end of period
    
    
    1,492,869
    
    
    
    477,443
    
    
    
    463,200Conversion optionsAt beginning of period
    
    
    25,475,368
    
    
    
    
    
    
    
    Movement for period (note 18)
    
    
    
    
    
    
    25,475,368
    
    
    
    At end of period
    
    
    25,475,368
    
    
    
    25,475,368
    
    
    
    Accumulated deficitAt beginning of period
    
    
    (110,890,555
    )
    
    
    (71,608,144
    )
    
    
    (11,031,402
    )Adjustment to reflect change in accounting for
employee stock options (note 2(t))
    
    
    
    
    
    
    
    
    
    
    (737,650
    )Adjustment to cummulative debentures
conversion expense (note 22)
    
    
    
    
    
    
    
    
    
    
    (6,899,211
    )Net (loss) for period
    
    
    (43,386,080
    )
    
    
    (39,282,411
    )
    
    
    (52,939,881
    )At end of period
    
    
    (154,276,635
    )
    
    
    (110,890,555
    )
    
    
    (71,608,144
    )Shareholders equity at end of period
    
    
    113,096,246
    
    
    
    144,068,194
    
    
    
    149,768,713
 See accompanying notes to the consolidated financial statements.
 73 INTEROIL 2006




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a.
    
    that engages in business activities
from which it may earn revenues and
incur expenses (including revenues and
expenses relating to transactions with
other segment of the same enterprise),
 75 INTEROIL 2006




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b.
    
    whose operating results are
regularly reviewed by the Companys
management to make decisions about
resources to be allocated to the segment
and assess its performance, andc.
    
    for which discrete financial
information is available.
   
 
             INTEROIL 2006       76




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77 INTEROIL 2006




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79 INTEROIL 2006




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Downstream
    
    0%  25%Midstream
    
    1%  33%Upstream
    
    4%  100%Corporate
    
    13%  33%
  
  
 
 INTEROIL 2006       80




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81 INTEROIL 2006




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(u) Earnings per share
 
 
   
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83 INTEROIL 2006




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INTEROIL 2006 84




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MidstreamYear ended
    
    
    
    
    
    - Refining &
    
    Midstream -
    
    
    
    
    
    
    
    
    
    ConsolidationDecember 31, 2006
    
    Upstream
    
    Marketing
    
    Liquefaction
    
    Downstream
    
    Corporate
    
    adjustments
    
    TotalRevenues from external
customers
    
    
    
    
    
    
    315,211,130
    
    
    
    
    
    
    
    195,876,804
    
    
    
    
    
    
    
    
    
    
    
    511,087,934Intersegment revenues
    
    
    
    
    
    
    136,583,916
    
    
    
    
    
    
    
    22,480
    
    
    
    8,669,933
    
    
    
    (145,276,329
    )
    
    
    Interest revenue
    
    
    2,820,888
    
    
    
    360,319
    
    
    
    
    
    
    
    100,750
    
    
    
    1,601,491
    
    
    
    (1,659,453
    )
    
    
    3,223,995Other revenue
    
    
    2,427,816
    
    
    
    
    
    
    
    
    
    
    
    1,319,787
    
    
    
    
    
    
    
    
    
    
    
    3,747,603Total segment revenue
    
    
    5,248,704
    
    
    
    452,155,365
    
    
    
    
    
    
    
    197,319,821
    
    
    
    10,271,424
    
    
    
    (146,935,782
    )
    
    
    518,059,532Cost of sales and
operating expenses
    
    
    
    
    
    
    451,374,165
    
    
    
    
    
    
    
    183,511,182
    
    
    
    
    
    
    
    (135,390,806
    )
    
    
    499,494,541Office and admin and
other expenses
    
    
    6,370,436
    
    
    
    8,017,245
    
    
    
    694,416
    
    
    
    7,671,208
    
    
    
    14,974,443
    
    
    
    (8,552,604
    )
    
    
    29,175,144Foreign exchange
(gain)/loss
    
    
    (61,423
    )
    
    
    (4,635,878
    )
    
    
    (219
    )
    
    
    (192,433
    )
    
    
    145,142
    
    
    
    
    
    
    
    (4,744,811
    )Exploration costs,
excluding exploration
impairment
    
    
    1,657,671
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,657,671Exploration impairment
    
    
    416,923
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    416,923Depreciation and
amortisation
    
    
    806,142
    
    
    
    10,729,546
    
    
    
    
    
    
    
    909,767
    
    
    
    37,247
    
    
    
    (130,030
    )
    
    
    12,352,672Accretion expense
    
    
    3,741,254
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,741,254Interest expense
    
    
    5,428
    
    
    
    10,880,779
    
    
    
    
    
    
    
    151,730
    
    
    
    7,894,820
    
    
    
    (1,659,453
    )
    
    
    17,273,304Total segment
expenses
    
    
    12,936,431
    
    
    
    476,365,857
    
    
    
    694,197
    
    
    
    192,051,454
    
    
    
    23,051,652
    
    
    
    (145,732,893
    )
    
    
    559,366,698(Loss)/income
before income taxes
and non-controlling interest
    
    
    (7,687,727
    )
    
    
    (24,210,492
    )
    
    
    (694,197
    )
    
    
    5,268,367
    
    
    
    (12,780,228
    )
    
    
    (1,202,889
    )
    
    
    (41,307,166
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,273,773
    )
    
    
    (69,100
    )
    
    
    
    
    
    
    (2,342,873
    )Non controlling interest
    
    
    
    
    
    
    259,169
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,790
    
    
    
    263,959Total net income/(loss)
    
    
    (7,687,727
    )
    
    
    (23,951,323
    )
    
    
    (694,197
    )
    
    
    2,994,594
    
    
    
    (12,849,328
    )
    
    
    (1,198,099
    )
    
    
    (43,386,080
    )Total assets
    
    
    68,260,887
    
    
    
    325,351,819
    
    
    
    (683,582
    )
    
    
    98,722,803
    
    
    
    393,700,711
    
    
    
    (397,187,776
    )
    
    
    488,164,862
 85 INTEROIL 2006




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MidstreamYear ended
    
    
    
    
    
    - Refining &
    
    Midstream -
    
    
    
    
    
    
    
    
    
    ConsolidationDecember 31, 2005
    
    Upstream
    
    Marketing
    
    Liquefaction
    
    Downstream
    
    Corporate
    
    adjustments
    
    TotalRevenues from
external customers
    
    
    
    
    
    
    356,326,763
    
    
    
    
    
    
    
    124,853,882
    
    
    
    
    
    
    
    
    
    
    
    481,180,645Intersegment
revenues
    
    
    
    
    
    
    80,094,501
    
    
    
    
    
    
    
    6,202
    
    
    
    5,345,017
    
    
    
    (85,445,720
    )
    
    
    Interest revenue
    
    
    1,011,511
    
    
    
    244,157
    
    
    
    
    
    
    
    95,317
    
    
    
    686,718
    
    
    
    (206,895
    )
    
    
    1,830,808Other revenue
    
    
    283,634
    
    
    
    496
    
    
    
    
    
    
    
    245,760
    
    
    
    30,509
    
    
    
    (32,129
    )
    
    
    528,270Total segment
revenue
    
    
    1,295,145
    
    
    
    436,665,917
    
    
    
    
    
    
    
    125,201,161
    
    
    
    6,062,244
    
    
    
    (85,684,744
    )
    
    
    483,539,723Cost of sales and
operating expenses
    
    
    
    
    
    
    436,490,554
    
    
    
    
    
    
    
    110,857,139
    
    
    
    
    
    
    
    (80,100,703
    )
    
    
    467,246,990Office and admin
and other expenses
    
    
    2,426,909
    
    
    
    9,204,613
    
    
    
    
    
    
    
    4,724,568
    
    
    
    11,608,822
    
    
    
    (5,465,658
    )
    
    
    22,499,254Foreign exchange
(gain)/loss
    
    
    (689,084
    )
    
    
    1,434,498
    
    
    
    
    
    
    
    843
    
    
    
    50,333
    
    
    
    
    
    
    
    796,590Exploration
costs, excluding
exploration impairment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exploration
impairment
    
    
    2,144,429
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,144,429Depreciation and
amortisation
    
    
    314,467
    
    
    
    10,598,134
    
    
    
    
    
    
    
    204,247
    
    
    
    49,732
    
    
    
    (130,030
    )
    
    
    11,036,550Accretion expense
    
    
    5,647,491
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,647,491Interest expense
    
    
    
    
    
    
    10,161,899
    
    
    
    
    
    
    
    225,450
    
    
    
    806,694
    
    
    
    (206,895
    )
    
    
    10,987,148Total segment
expenses
    
    
    9,844,212
    
    
    
    467,889,698
    
    
    
    
    
    
    
    116,012,247
    
    
    
    12,515,581
    
    
    
    (85,903,286
    )
    
    
    520,358,452(Loss)/income
before income taxes
and non- controlling interest
    
    
    (8,549,067
    )
    
    
    (31,223,781
    )
    
    
    
    
    
    
    9,188,914
    
    
    
    (6,453,337
    )
    
    
    218,542
    
    
    
    (36,818,729
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,755,845
    )
    
    
    (76,149
    )
    
    
    
    
    
    
    (2,831,994
    )Non controlling
interest
    
    
    
    
    
    
    362,140
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,172
    
    
    
    368,312Total net income/
(loss)
    
    
    (8,549,067
    )
    
    
    (30,861,641
    )
    
    
    
    
    
    
    6,433,069
    
    
    
    (6,529,486
    )
    
    
    224,714
    
    
    
    (39,282,411
    )Total assets
    
    
    75,587,143
    
    
    
    314,904,035
    
    
    
    
    
    
    
    47,342,109
    
    
    
    317,227,597
    
    
    
    (325,503,788
    )
    
    
    429,557,096
 INTEROIL 2006 86




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Midstream -Year ended
    
    
    
    
    
    Refining and
    
    Midstream -
    
    
    
    
    
    
    
    
    
    ConsolidationDecember 31, 2004
    
    Upstream
    
    Marketing
    
    Liquefaction
    
    Downstream
    
    Corporate
    
    adjustments
    
    TotalRevenues from external
customers
    
    
    
    
    
    
    26,309,547
    
    
    
    
    
    
    
    62,410,291
    
    
    
    
    
    
    
    (18,075,352
    )
    
    
    70,644,486Intersegment revenues
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    489,111
    
    
    
    3,787,944
    
    
    
    (4,277,055
    )
    
    
    Interest revenue
    
    
    151,780
    
    
    
    8,761
    
    
    
    
    
    
    
    56,896
    
    
    
    165,024
    
    
    
    
    
    
    
    382,461Other revenue
    
    
    (39,267
    )
    
    
    (63,031
    )
    
    
    
    
    
    
    205,836
    
    
    
    92,799
    
    
    
    
    
    
    
    196,337Total segment revenue
    
    
    112,513
    
    
    
    26,255,277
    
    
    
    
    
    
    
    63,162,134
    
    
    
    4,045,767
    
    
    
    (22,352,407
    )
    
    
    71,223,284Cost of sales and
operating expenses
    
    
    
    
    
    
    27,685,347
    
    
    
    
    
    
    
    53,158,737
    
    
    
    
    
    
    
    (15,499,568
    )
    
    
    65,344,516Office and admin and
other expenses
    
    
    1,649,191
    
    
    
    3,167,216
    
    
    
    
    
    
    
    3,146,905
    
    
    
    10,538,730
    
    
    
    (3,766,608
    )
    
    
    14,735,434Foregin exchange
(Gain)/loss
    
    
    
    
    
    
    (34,121
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (34,121
    )Exploration costs,
excluding exploration
impairment
    
    
    2,903,313
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,903,313Exploration impairment
    
    
    35,566,761
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,566,761Depreciation and
amortisation
    
    
    12,510
    
    
    
    311,986
    
    
    
    
    
    
    
    224,214
    
    
    
    90,365
    
    
    
    
    
    
    
    639,075Interest expense
    
    
    4,932
    
    
    
    843,888
    
    
    
    
    
    
    
    455,368
    
    
    
    1,899,027
    
    
    
    
    
    
    
    3,203,215Total segment
expenses
    
    
    40,136,707
    
    
    
    31,974,316
    
    
    
    
    
    
    
    56,985,224
    
    
    
    12,528,122
    
    
    
    (19,266,176
    )
    
    
    122,358,193(Loss)/income before
income taxes and non-
controlling interest
    
    
    (40,024,194
    )
    
    
    (5,719,039
    )
    
    
    
    
    
    
    6,176,910
    
    
    
    (8,482,355
    )
    
    
    (3,086,231
    )
    
    
    (51,134,909
    )Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,899,803
    )
    
    
    24,740
    
    
    
    
    
    
    
    (1,875,063
    )Non controlling interest
    
    
    
    
    
    
    68,961
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,130
    
    
    
    70,091Total net income/(loss)
    
    
    (40,024,194
    )
    
    
    (5,650,078
    )
    
    
    
    
    
    
    4,277,107
    
    
    
    (8,457,615
    )
    
    
    (3,085,101
    )
    
    
    (52,939,881
    )Total assets
    
    
    21,570,219
    
    
    
    310,941,494
    
    
    
    
    
    
    
    34,436,144
    
    
    
    211,530,962
    
    
    
    (192,636,636
    )
    
    
    385,842,184
 
 87 INTEROIL 2006




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December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Cash on deposit
    
    
    31,681,435
    
    
    
    59,597,724
    
    
    
    24,224,523Bank term deposits- Papua New Guinea kina deposits
    
    
    
    
    
    
    
    
    
    
    4,315,513- Australian dollar deposits
    
    
    
    
    
    
    4,083
    
    
    
    4,36231,681,435
    
    
    
    59,601,807
    
    
    
    28,544,398
  December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Cash paid during the yearInterest
    
    
    8,548,552
    
    
    
    13,373,832
    
    
    
    1,444,006Income taxes
    
    
    2,306,218
    
    
    
    1,656,985
    
    
    
    1,914,459Interest received
    
    
    3,154,380
    
    
    
    1,800,062
    
    
    
    671,479Non-cash investing and financing activities:Deferred financing costs included in accounts payable
and accrued liabilities
    
    
    500,000
    
    
    
    100,000
    
    
    
    Accrued financing costs and deferred financing costs
    
    
    
    
    
    
    
    
    
    
    834,439Increase in additional paid up capital as a result
of a change in accounting policy for stock based
compensation (2(t))
    
    
    
    
    
    
    
    
    
    
    645,216Decrease in plant and equipment as a result of
impairment
    
    
    755,857
    
    
    
    
    
    
    
    Deferred liquefaction project liability
    
    
    6,553,080
    
    
    
    
    
    
    
    Increase in share capital from:the exercise of share options
    
    
    532,232
    
    
    
    577,086
    
    
    
    646,216the exercise of warrants
    
    
    
    
    
    
    120,375
    
    
    
    change in accounting policy for stock based
compensation (note 2(t))
    
    
    
    
    
    
    
    
    
    
    92,434transfer of deferred transaction costs on
conversion of the debenture
    
    
    
    
    
    
    
    
    
    
    (3,093,734
    )transfer of carrying value of debentures to share
capital on conversion of the securities
    
    
    
    
    
    
    
    
    
    
    42,890,448conversion of indirect participation interest into
share capital
    
    
    7,948,691
    
    
    
    923,000
    
    
    
    9,226,260shares issued to induce conversion of debentures
    
    
    
    
    
    
    
    
    
    
    6,976,800transaction costs being attributed to share capital
transaction
    
    
    
    
    
    
    
    
    
    
    300,000Movement in accumulated deficit as a result of the
inducement paid on conversion of the debentures
    
    
    
    
    
    
    
    
    
    
    (6,899,211
    )
  INTEROIL 2006 88




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Cash deposit on working capital facility (5.0%)
    
    
    29,301,940
    
    
    
    16,452,216
    
    
    
    15,497,127Cash restricted  Current
    
    
    29,301,940
    
    
    
    16,452,216
    
    
    
    15,497,127Cash deposit on secured loan (3.9%)
    
    
    647,502
    
    
    
    106,267
    
    
    
    Debt reserve for secured loan
    
    
    2,420,000
    
    
    
    
    
    
    
    Bank term deposits on Petroleum Prospecting Licenses (0.8%)
    
    
    107,997
    
    
    
    103,786
    
    
    
    102,096Cash deposit on office premises (4.5%)
    
    
    41,785
    
    
    
    
    
    
    
    Cash restricted  Non-current
    
    
    3,217,284
    
    
    
    210,053
    
    
    
    102,09632,519,224
    
    
    
    16,662,269
    
    
    
    15,599,223
 89 INTEROIL 2006




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##### Table of Contents



Derivative
    
    Type
    
    Notional volumes (bbls)Naphtha swap
    
    Sell Naphtha
    
    
    175,000
  Derivative
    
    Type
    
    Notional volumes (bbls)Crude swap
    
    Sell crude
    
    
    300,000Crude swap
    
    Buy crude
    
    
    250,000Jet kerosene crack spread swap
    
    Sell jet kerosene/buy crude
    
    
    249,999
  Derivative
    
    Type
    
    Notional volumes (bbls)Naphtha swap
    
    Sell naphtha
    
    
    50,000Naphtha crack spread swap
    
    Sell naphtha/buy crude
    
    
    50,000
 INTEROIL 2006 90




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Midstream  refining and marketing
(crude oil feedstock)
    
    
    12,795,356
    
    
    
    5,019,580
    
    
    
    3,971,982Midstream  refining and marketing
(refined petroleum product)
    
    
    22,329,270
    
    
    
    25,967,357
    
    
    
    16,396,975Midstream  refining and marketing (parts inventory)
    
    
    46,646
    
    
    
    
    
    
    
    Downstream (refined petroleum product)
    
    
    32,422,296
    
    
    
    13,100,547
    
    
    
    7,547,94567,593,568
    
    
    
    44,087,484
    
    
    
    27,916,902
 91      INTEROIL 2006




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##### Table of Contents



Corporate &December 31, 2006
    
    Upstream
    
    Midstream
    
    Downstream
    
    Consolidated
    
    TotalsPlant and equipment
    
    
    1,247,201
    
    
    
    249,741,042
    
    
    
    37,697,458
    
    
    
    146,797
    
    
    
    288,832,498Deferred project costs and work in progress
    
    
    
    
    
    
    723,566
    
    
    
    715,653
    
    
    
    
    
    
    
    1,439,219Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,990,688
    )
    
    
    (2,990,688
    )Accumulated depreciation and amortisation
    
    
    (153,455
    )
    
    
    (21,760,341
    )
    
    
    (22,697,003
    )
    
    
    (28,153
    )
    
    
    (44,638,952
    )Net book value
    
    
    1,093,746
    
    
    
    228,704,267
    
    
    
    15,716,108
    
    
    
    (2,872,044
    )
    
    
    242,642,077Capital expenditure
    
    
    
    
    
    
    11,948,960
    
    
    
    10,543,840
    
    
    
    156,817
    
    
    
    22,649,617
 Corporate &December 31, 2005
    
    Upstream
    
    Midstream
    
    Downstream
    
    Consolidated
    
    TotalsPlant and equipment
    
    
    5,657,125
    
    
    
    238,078,544
    
    
    
    12,164,417
    
    
    
    331,183
    
    
    
    256,231,269Deferred project costs and work in progress
    
    
    
    
    
    
    1,987,085
    
    
    
    1,386,488
    
    
    
    
    
    
    
    3,373,573Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,120,718
    )
    
    
    (3,120,718
    )Accumulated depreciation and amortisation
    
    
    (308,378
    )
    
    
    (11,245,748
    )
    
    
    (7,332,042
    )
    
    
    (198,808
    )
    
    
    (19,084,976
    )Net book value
    
    
    5,348,747
    
    
    
    228,819,881
    
    
    
    6,218,863
    
    
    
    (2,988,343
    )
    
    
    237,399,148Capital expenditure
    
    
    
    
    
    
    3,284,108
    
    
    
    1,902,334
    
    
    
    95,782
    
    
    
    5,282,224
 Corporate &December 31, 2004
    
    Upstream
    
    Midstream
    
    Downstream
    
    Consolidated
    
    TotalsPlant and equipment
    
    
    5,659,248
    
    
    
    236,551,876
    
    
    
    10,875,211
    
    
    
    263,217
    
    
    
    253,349,552Deferred project costs and work in progress
    
    
    
    
    
    
    
    
    
    
    949,924
    
    
    
    
    
    
    
    949,924Consolidation entries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,002,214
    )
    
    
    (2,002,214
    )Accumulated depreciation and amortisation
    
    
    (19,792
    )
    
    
    (419,629
    )
    
    
    (7,317,596
    )
    
    
    (176,890
    )
    
    
    (7,933,907
    )Net book value
    
    
    5,639,456
    
    
    
    236,132,247
    
    
    
    4,507,539
    
    
    
    (1,915,887
    )
    
    
    244,363,355Capital expenditure
    
    
    1,131
    
    
    
    40,532,990
    
    
    
    1,320,644
    
    
    
    83,920
    
    
    
    41,938,685
 INTEROIL 2006 92




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Drilling equipment
    
    
    18,242,972
    
    
    
    15,100,860
    
    
    
    5,353,471Petroleum Prospecting License drilling programs at cost
    
    
    19,206,762
    
    
    
    1,298,632
    
    
    
    1,251,889PPL 238Other properties
    
    
    
    
    
    
    
    
    
    
    37,449,734
    
    
    
    16,399,492
    
    
    
    6,605,360
  December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Exploration costs, excluding exploration impairment
    
    
    1,657,671
    
    
    
    
    
    
    
    2,903,313Exploration impairmentCosts incurred in prior years
    
    
    
    
    
    
    2,059,367
    
    
    
    16,576,982Costs incurred in current year
    
    
    416,923
    
    
    
    85,062
    
    
    
    18,989,779Total exploration impairment
    
    
    416,923
    
    
    
    2,144,429
    
    
    
    35,566,7612,074,594
    
    
    
    2,144,429
    
    
    
    38,470,074
 
 93 INTEROIL 2006




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $(Loss) before income taxes and non controlling
interest
    
    
    (41,307,166
    )
    
    
    (36,818,729
    )
    
    
    (51,134,909
    )Statutory income tax rate
    
    
    35.10
    %
    
    
    35.10
    %
    
    
    35.12
    %Computed tax (benefit)
    
    
    (14,498,815
    )
    
    
    (12,923,374
    )
    
    
    (17,958,580
    )Effect on income tax of:Losses in foreign jurisdictions not deductible
    
    
    251,639
    
    
    
    2,834,689
    
    
    
    2,273,530Non-deductible stock compensation expense
    
    
    693,601
    
    
    
    585,783
    
    
    
    424,924Gains and losses on foreign exchange
    
    
    (1,358,526
    )
    
    
    268,843
    
    
    
    58,659Tax rate differential in foreign jurisditions
    
    
    1,103,122
    
    
    
    1,224,361
    
    
    
    (341,613
    )Over provision for tax in prior years
    
    
    (51,632
    )
    
    
    (113,950
    )
    
    
    (42,874
    )Tax losses for which no future tax benefit has been
brought to account
    
    
    12,166,624
    
    
    
    9,845,189
    
    
    
    2,696,330Temporary differences for which no future tax
benefit has been brought to account
    
    
    778,301
    
    
    
    1,123,458
    
    
    
    14,552,726Temporary differences brought to account on
acquisition of subsidiary
    
    
    1,135,181
    
    
    
    (34,902
    )
    
    
    (488,027
    )Other  net
    
    
    2,123,377
    
    
    
    21,897
    
    
    
    699,9882,342,872
    
    
    
    2,831,994
    
    
    
    1,875,063
  December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Future tax assetsTemporary differencesPlant and equipment
    
    
    3,030,479
    
    
    
    2,665,173
    
    
    
    2,263,654Exploration expenditure
    
    
    24,828,156
    
    
    
    12,184,351
    
    
    
    11,541,022Other  net
    
    
    122,713
    
    
    
    99,834
    
    
    
    127,24027,981,348
    
    
    
    14,949,358
    
    
    
    13,931,916Losses carried forward
    
    
    27,060,498
    
    
    
    17,373,507
    
    
    
    4,850,38055,041,846
    
    
    
    32,322,865
    
    
    
    18,782,296Less valuation allowance
    
    
    (53,617,833
    )
    
    
    (31,263,967
    )
    
    
    (17,478,665
    )1,424,013
    
    
    
    1,058,898
    
    
    
    1,303,631
  INTEROIL 2006 94




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Working capital credit facility
    
    
    170,000,000
    
    
    
    150,000,000
    
    
    
    100,000,000Less amounts included in the working capital
facility liability:Short term advances
    
    
    (13,201,940
    )
    
    
    (47,527,408
    )
    
    
    (63,485,637
    )Discounted receivables (note 8)
    
    
    (23,671,568
    )
    
    
    (23,196,914
    )
    
    
    (13,034,904
    )(36,873,508
    )
    
    
    (70,724,322
    )
    
    
    (76,520,541
    )Less: other amounts outstanding under the facility:Letters of credit outstanding
    
    
    (79,000,000
    )
    
    
    (33,765,000
    )
    
    
    (14,000,000
    )Hedging facility
    
    
    (1,500,000
    )
    
    
    (1,500,000
    )
    
    
    Working capital credit facility available for use
    
    
    52,626,492
    
    
    
    44,010,678
    
    
    
    9,479,459
 95
    
    INTEROILANNUAL REPORT 2006




---



##### Table of Contents



$Cash
    
    
    4,989,895Trade receivables
    
    
    6,288,834Inventory
    
    
    20,429,728Other assets
    
    
    2,190,226Future income tax benefit
    
    
    1,698,224Property, plant and equipment
    
    
    8,799,691Total assets acquired
    
    
    44,396,598Accounts payable and accrued liabilities
    
    
    (11,815,188
    )Net assets acquired
    
    
    32,581,410
    INTEROIL 2006      96




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##### Table of Contents



$Cash
    
    
    5,859,517Trade receivables
    
    
    8,241,400Inventory
    
    
    6,759,089Other assets
    
    
    1,614,249Future income tax benefit
    
    
    640,284Property, plant and equipment
    
    
    3,180,530Total assets acquired
    
    
    26,295,069Accounts payable and accrued liabilities
    
    
    (13,399,720
    )Net assets acquired
    
    
    12,895,349
     97       INTEROIL 2006




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INTEROIL 2006       98




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Secured loan (OPIC)  current portion
    
    
    13,500,000
    
    
    
    9,000,000
    
    
    
    9,000,000Secured loan (OPIC)  non current portion
    
    
    62,500,000
    
    
    
    71,500,000
    
    
    
    76,000,000Secured loan (bridging facility)  non current portion
    
    
    121,666,433
    
    
    
    
    
    
    
    Total non current secured loan
    
    
    184,166,433
    
    
    
    71,500,000
    
    
    
    76,000,000Total secured loan
    
    
    197,666,433
    
    
    
    80,500,000
    
    
    
    85,000,000
         99       INTEROIL 2006




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##### Table of Contents



December 31,
    
    December 31,
    
    December 31,2006
    
    2005
    
    2004$
    
    $
    
    $Current
portion
    
    
    12,460,725
    
    
    
    35,092,558
    
    
    
    13,749,852Non current
portion
    
    
    36,827,877
    
    
    
    30,166,311
    
    
    
    Total
indirect
participation
    
    
    49,288,602
    
    
    
    65,258,869
    
    
    
    13,749,852
  
 INTEROIL 2006      100




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##### Table of Contents



101      INTEROIL 2006




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##### Table of Contents



December 31,
    
    December 31,
    
    December 31,2006
    
    2005
    
    2004$
    
    $
    
    $Current
portion
    
    
    730,534
    
    
    
    
    
    
    
    Non current
portion
    
    
    1,012,999
    
    
    
    9,685,830
    
    
    
    10,608,830Total indirect
participation
interest 
PNGDV
    
    
    1,743,533
    
    
    
    9,685,830
    
    
    
    10,608,830
          INTEROIL 2006       102




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##### Table of Contents



Number of shares
    
    $January 1, 2003
    
    
    20,585,943
    
    
    
    94,120,609Shares issued for cash
    
    
    3,817,500
    
    
    
    61,060,640Shares issued for debt
    
    
    31,240
    
    
    
    316,359Shares issued on exercise of options
    
    
    381,278
    
    
    
    1,951,592January 1, 2004
    
    
    24,815,961
    
    
    
    157,449,200Shares issued for debt
    
    
    3,184,828
    
    
    
    56,698,121Shares issued on exercise of options
    
    
    310,095
    
    
    
    2,666,333December 31, 2004
    
    
    28,310,884
    
    
    
    216,813,654Shares issued for debt
    
    
    52,000
    
    
    
    923,000Shares issued on exercise of warrants
    
    
    19,168
    
    
    
    540,346Shares issued on exercise of options
    
    
    781,268
    
    
    
    5,657,500December 31, 2005
    
    
    29,163,320
    
    
    
    223,934,500Shares issued on exercise of options
    
    
    132,285
    
    
    
    2,006,175Shares issued on amendment of indirect participation interest  PNGDV
    
    
    575,575
    
    
    
    7,948,691December 31, 2006
    
    
    29,871,180
    
    
    
    233,889,366
 
 103       INTEROIL 2006




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##### Table of Contents



December 31, 2006
    
    December 31, 2005
    
    December 31, 2004Number of
    
    Weighted average
    
    
    
    
    
    Weighted averageStock options outstanding
    
    options
    
    exercise price $
    
    Number of options
    
    exercise price $
    
    Number of optionsOutstanding
at beginning of year
    
    
    746,800
    
    
    
    22.23
    
    
    
    1,162,322
    
    
    
    9.91
    
    
    
    1,363,265Granted
    
    
    725,500
    
    
    
    15.87
    
    
    
    516,450
    
    
    
    25.82
    
    
    
    224,460Exercised
    
    
    (132,285
    )
    
    
    (11.14
    )
    
    
    (781,322
    )
    
    
    (6.50
    )
    
    
    (310,095
    )Forfeited
    
    
    (285,433
    )
    
    
    (18.01
    )
    
    
    (74,000
    )
    
    
    (13.11
    )
    
    
    (100,308
    )Expired
    
    
    (41,082
    )
    
    
    (15.36
    )
    
    
    (76,650
    )
    
    
    (26.01
    )
    
    
    (15,000
    )Outstanding at end
of year
    
    
    1,013,500
    
    
    
    20.59
    
    
    
    746,800
    
    
    
    22.23
    
    
    
    1,162,322
 Options issued and outstanding
    
    Options exercisableWeighted averageNumber of
    
    Weighted average
    
    remaining term
    
    
    
    
    
    Weighted averageRange of exercise prices $
    
    options
    
    exercise price $
    
    (years)
    
    Number of options
    
    exercise price $2.75 to 5.00
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5.01 to 8.00
    
    
    10,000
    
    
    
    5.27
    
    
    
    0.39
    
    
    
    10,000
    
    
    
    5.278.01 to 12.00
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13.01 to 24.00
    
    
    714,000
    
    
    
    18.03
    
    
    
    3.63
    
    
    
    150,000
    
    
    
    18.8424.00 to 31.00
    
    
    289,500
    
    
    
    27.44
    
    
    
    1.93
    
    
    
    77,500
    
    
    
    30.271,013,500
    
    
    
    20.59
    
    
    
    2.97
    
    
    
    237,500
    
    
    
    22.00
 INTEROIL 2006      104




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##### Table of Contents



Risk free
    
    Dividend
    
    
    
    
    
    Weighted average expectedYear
    
    Period
    
    interest rate (%)
    
    yield
    
    Volatility (%)
    
    life for options2006
    
    October 1 to December 31
    
    
    4.6
    
    
    
    
    
    
    
    65
    
    
    
    5.02006
    
    July 1 to September 30
    
    
    5.1
    
    
    
    
    
    
    
    68
    
    
    
    4.22006
    
    January 1 to June 30
    
    
    4.4
    
    
    
    
    
    
    
    60
    
    
    
    4.82005
    
    July 1 to December 31
    
    
    2.5
    
    
    
    
    
    
    
    55
    
    
    
    3.62005
    
    January 1 to June 30
    
    
    2.5
    
    
    
    
    
    
    
    45
    
    
    
    3.22004
    
    January 1 to December 31
    
    
    2.5
    
    
    
    
    
    
    
    45
    
    
    
    3.8
      105       INTEROIL 2006




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##### Table of Contents



24.
    
    COMMITMENTS AND CONTINGENCIES
  Total
    
    Less than 1 year
    
    1-2 years
    
    2-3 years
    
    3-4 years
    
    4-5 years
    
    More than 5 years000
    
    
    000
    
    
    000
    
    
    000
    
    
    000
    
    
    000
    
    
    000Secured loan obligations
    
    
    197,666
    
    
    
    13,500
    
    
    
    130,666
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    26,500Accrued financing costs
    
    
    1,450
    
    
    
    363
    
    
    
    1,087
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Acquisition of subsidiary
 IPL PNG Ltd
    
    
    1,771
    
    
    
    1,771
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Indirect participation
interest  PNGDV (note 18)
    
    
    1,744
    
    
    
    731
    
    
    
    1,013
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Indirect participation
interest (note 18)
    
    
    49,289
    
    
    
    12,461
    
    
    
    21,087
    
    
    
    15,740
    
    
    
    
    
    
    
    
    
    
    
    Petroleum prospecting
and retention licenses (a)
    
    
    5,237
    
    
    
    1,877
    
    
    
    3,360
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    257,157
    
    
    
    30,703
    
    
    
    157,213
    
    
    
    24,740
    
    
    
    9,000
    
    
    
    9,000
    
    
    
    26,500
 (a)
    
    The amount pertaining to the petroleum
prospecting and retention licenses
represents the amount InterOil has committed
to spend to its joint venture partners. In
addition to this amount, InterOil must drill
an exploration well on PPL 237 in the two
year period commencing March 2007. As the
cost of drilling this well cannot be
estimated, it is not included within the
above table.
    25.
    
    SUBSEQUENT EVENTS
  26.
    
    RECONCILIATION TO
ACCOUNTING PRINCIPLES GENERALLY ACCEPTED
IN THE UNITED STATES
  INTEROIL 006 106




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##### Table of Contents



Year endedDecember 31, 2006 $
    
    December 31, 2005 $
    
    December 31, 2004 $Canadian
    
    
    
    
    
    Canadian
    
    
    
    
    
    CanadianGAAP
    
    U.S. GAAP
    
    GAAP
    
    U.S. GAAP
    
    GAAP
    
    U.S. GAAPRevenueSales and operating revenues (1)
    
    
    511,087,934
    
    
    
    511,189,438
    
    
    
    481,180,645
    
    
    
    481,180,645
    
    
    
    70,644,486
    
    
    
    121,974,268Interest income
    
    
    3,223,995
    
    
    
    
    
    
    
    1,830,808
    
    
    
    
    
    
    
    382,461
    
    
    
    Other income
    
    
    3,747,603
    
    
    
    
    
    
    
    528,270
    
    
    
    
    
    
    
    196,337
    
    
    
    518,059,532
    
    
    
    511,189,438
    
    
    
    483,539,723
    
    
    
    481,180,645
    
    
    
    71,223,284
    
    
    
    121,974,268ExpensesCost of sales and operating expenses
(excluding depreciation shown below) (1)
    
    
    499,494,540
    
    
    
    499,584,532
    
    
    
    467,246,990
    
    
    
    467,400,576
    
    
    
    65,344,516
    
    
    
    129,871,126Administrative and general expenses
(1), (2)
    
    
    20,728,618
    
    
    
    20,762,574
    
    
    
    14,672,793
    
    
    
    14,687,717
    
    
    
    7,831,550
    
    
    
    8,081,740Depreciation and amortization (1)
    
    
    12,352,672
    
    
    
    11,591,513
    
    
    
    11,036,550
    
    
    
    10,836,696
    
    
    
    639,075
    
    
    
    1,462,953Exploration costs, excluding exploration
impairment
    
    
    1,657,671
    
    
    
    1,657,671
    
    
    
    
    
    
    
    
    
    
    
    2,903,313
    
    
    
    2,903,313Exploration impairment
    
    
    416,923
    
    
    
    416,923
    
    
    
    2,144,429
    
    
    
    2,144,429
    
    
    
    35,566,761
    
    
    
    35,566,761Legal and professional fees (1)
    
    
    3,937,517
    
    
    
    3,937,517
    
    
    
    3,606,415
    
    
    
    3,606,415
    
    
    
    3,573,727
    
    
    
    3,655,631Short term borrowing costs
    
    
    8,643,927
    
    
    
    8,643,927
    
    
    
    8,855,857
    
    
    
    8,855,857
    
    
    
    4,705,190
    
    
    
    4,705,190Long term borrowing costs (1)
    
    
    11,691,485
    
    
    
    11,691,485
    
    
    
    6,351,337
    
    
    
    6,351,337
    
    
    
    1,401,256
    
    
    
    1,897,029Accretion expense
    
    
    3,741,254
    
    
    
    3,741,254
    
    
    
    5,647,491
    
    
    
    5,647,491
    
    
    
    
    
    
    
    Debt conversion expense (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,976,800Loss/(gain) on revaluation of conversion
options (6)
    
    
    
    
    
    
    19,755,017
    
    
    
    
    
    
    
    (4,279,284
    )
    
    
    
    
    
    
    Loss on amendment of indirect
participation interest  PNGDV (16)
    
    
    1,446,901
    
    
    
    1,446,901
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Foreign exchange loss/(gain) (2)
    
    
    (4,744,810
    )
    
    
    (4,744,810
    )
    
    
    796,590
    
    
    
    796,590
    
    
    
    392,805
    
    
    
    392,805Non-controlling interest (7)
    
    
    (263,959
    )
    
    
    (265,865
    )
    
    
    (368,312
    )
    
    
    (368,475
    )
    
    
    (70,091
    )
    
    
    (265,624
    )Interest income
    
    
    
    
    
    
    (3,223,995
    )
    
    
    
    
    
    
    (1,830,808
    )
    
    
    
    
    
    
    (382,461
    )Other income
    
    
    
    
    
    
    (3,747,603
    )
    
    
    
    
    
    
    (528,270
    )
    
    
    
    
    
    
    (196,337
    )559,102,739
    
    
    
    571,247,041
    
    
    
    519,990,140
    
    
    
    513,320,271
    
    
    
    122,288,102
    
    
    
    194,668,926Loss before income taxes
    
    
    (41,043,207
    )
    
    
    (60,057,603
    )
    
    
    (36,450,417
    )
    
    
    (32,139,626
    )
    
    
    (51,064,818
    )
    
    
    (72,694,658
    )Income tax expense (3)
    
    
    (2,342,873
    )
    
    
    (2,342,873
    )
    
    
    (2,831,994
    )
    
    
    (2,831,994
    )
    
    
    (1,875,063
    )
    
    
    (1,875,063
    )Loss before cumulative effect of
accounting change
    
    
    (43,386,080
    )
    
    
    (62,400,476
    )
    
    
    (39,282,411
    )
    
    
    (34,971,620
    )
    
    
    (52,939,881
    )
    
    
    (74,569,721
    )Cumulative effect of accounting change (4)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (737,650
    )Net loss
    
    
    (43,386,080
    )
    
    
    (62,400,476
    )
    
    
    (39,282,411
    )
    
    
    (34,971,620
    )
    
    
    (52,939,881
    )
    
    
    (75,307,371
    )
 107 INTEROIL 2006




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##### Table of Contents



Year endedDecember 31,
    
    December 31,
    
    December 31,2006
    
    2005
    
    2004$
    
    $
    
    $Net loss as shown in the Canadian GAAP financial statements
    
    
    (43,386,080
    )
    
    
    (39,282,411
    )
    
    
    (52,939,881
    )Description of items having the effect of increasing reported incomeDecrease in depreciation and amortization due to difference in date
of commencement of operations of refinery (1)
    
    
    761,159
    
    
    
    199,854
    
    
    
    Gain on revaluation of conversion options (6)
    
    
    
    
    
    
    4,279,284
    
    
    
    Decrease in non-controlling interest expense (7)
    
    
    1,907
    
    
    
    163
    
    
    
    195,533Decrease in administrative and general expenses from ineffective
portion of hedges (2)
    
    
    
    
    
    
    22,456
    
    
    
    Increase in sales as a result of items being ineligible for capitalization
due to difference in date of commencement of operations of refinery(1)
    
    
    
    
    
    
    
    
    
    
    51,329,782Increase in sales from ineffective portion of hedges (2)
    
    
    101,504
    
    
    
    
    
    
    
    Decrease in foreign exchange loss (2)
    
    
    
    
    
    
    
    
    
    
    Description of items having the effect of decreasing reported incomeLoss on revaluation of conversion options (6)
    
    
    (19,755,017
    )
    
    
    
    
    
    
    Increase in depreciation and amortization due to difference in date of
commencement of operations of refinery (1)
    
    
    
    
    
    
    
    
    
    
    (823,878
    )Increase in non-controlling interest expense (7)
    
    
    
    
    
    
    
    
    
    
    Increase in cost of sales and operating expenses as a result of items
being ineligible for capitalization due to difference in date of
commencement of operations of refinery (1)
    
    
    
    
    
    
    (153,586
    )
    
    
    (64,526,610
    )Increase in cost of sales from ineffective portion of hedges (2)
    
    
    (89,992
    )
    
    
    
    
    
    
    Increase in administrative and general expenses from ineffective
portion of hedges (2)
    
    
    (33,956
    )
    
    
    
    
    
    
    Increase in administrative and general expenses as a result of items
being ineligible for capitalization due to difference in date of
commencement of operations of refinery (1)
    
    
    
    
    
    
    (37,380
    )
    
    
    (250,190
    )Increase in legal and professional fees as a result of items being
ineligible for capitalization due to difference in date of commencement
of operations of refinery (1)
    
    
    
    
    
    
    
    
    
    
    (81,904
    )Increase in long term borrowing costs as a result of items being
ineligible for capitalization due to difference in date of commencement
of operations of refinery (1)
    
    
    
    
    
    
    
    
    
    
    (495,773
    )Debt conversion expense (5)
    
    
    
    
    
    
    
    
    
    
    (6,976,800
    )Cumulative effect of accounting change relating to stock compensation
    
    
    
    
    
    
    
    
    
    
    (737,650
    )Net loss according to US GAAP
    
    
    (62,400,476
    )
    
    
    (34,971,620
    )
    
    
    (75,307,371
    )
  Year endedDecember 31, 2006
    
    December 31, 2005
    
    December 31, 2004$
    
    $
    
    $Net loss in accordance with U.S. GAAP, net of tax
    
    
    (62,400,476
    )
    
    
    (34,971,620
    )
    
    
    (75,307,371
    )Foreign currency translation reserve, net of tax
    
    
    1,015,426
    
    
    
    14,243
    
    
    
    463,200Deferred hedge gain, net of tax
    
    
    (993,153
    )
    
    
    457,184
    
    
    
    537,358Total other comprehensive income, net of tax
    
    
    22,273
    
    
    
    471,427
    
    
    
    1,000,558Comprehensive loss, net of tax
    
    
    (62,378,203
    )
    
    
    (34,500,193
    )
    
    
    (74,306,813
    )
 INTEROIL 2006 108




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Foreign currency
    
    
    
    
    
    
    Total accumulated othertranslation reserve
    
    
    Deferred hedge gain
    
    
    comprehensive incomeAOCI balance as of December 31, 2003
    
    
    
    
    
    
    
    
    
    
    Current period change
    
    
    463,200
    
    
    
    537,358
    
    
    
    1,000,558AOCI balance as of December 31, 2004
    
    
    463,200
    
    
    
    537,358
    
    
    
    1,000,558Current period change
    
    
    14,243
    
    
    
    457,184
    
    
    
    471,427AOCI balance as of December 31, 2005
    
    
    477,443
    
    
    
    994,542
    
    
    
    1,471,985Current period change
    
    
    1,015,426
    
    
    
    (993,153
    )
    
    
    22,273AOCI balance as of December 31, 2006
    
    
    1,492,869
    
    
    
    1,389
    
    
    
    1,494,258
    Weighted average number of shares on which
    
    Year ended December 31,earnings per share calculations are based inaccordance with U.S. GAAP
    
    2006
    
    2005
    
    2004Basic
    
    
    29,602,360
    
    
    
    28,832,263
    
    
    
    25,373,575Effect of dilutive options
    
    
    
    
    
    
    
    
    
    
    Diluted
    
    
    29,602,360
    
    
    
    28,832,263
    
    
    
    25,373,575Net income/(loss) per share in accordance
with U.S. GAAPBasic
    
    
    (2.11
    )
    
    
    (1.21
    )
    
    
    (2.97
    )Diluted
    
    
    (2.11
    )
    
    
    (1.21
    )
    
    
    (2.97
    )
 109      INTEROIL 2006




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December 31, 2006
    
    December 31, 2005
    
    December 31, 2004Canadian
    
    
    
    
    
    Canadian
    
    
    
    
    
    CanadianGAAP
    
    U.S. GAAP
    
    GAAP
    
    U.S. GAAP
    
    GAAP
    
    U.S. GAAPCurrent assets
    
    
    201,714,996
    
    
    
    201,714,996
    
    
    
    173,442,742
    
    
    
    173,442,742
    
    
    
    132,258,350
    
    
    
    132,258,350Oil and gas properties
    
    
    37,449,734
    
    
    
    37,449,734
    
    
    
    16,399,492
    
    
    
    16,399,492
    
    
    
    6,605,360
    
    
    
    6,605,360Capital assets (1),(2)
    
    
    242,642,077
    
    
    
    231,175,281
    
    
    
    237,399,148
    
    
    
    225,171,193
    
    
    
    244,363,355
    
    
    
    232,496,306Deferred financing costs
    
    
    1,716,757
    
    
    
    1,716,757
    
    
    
    1,256,816
    
    
    
    1,256,816
    
    
    
    1,311,488
    
    
    
    1,311,488Restricted Cash
    
    
    3,217,284
    
    
    
    3,217,284
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Future income tax benefit (3)
    
    
    1,424,014
    
    
    
    1,424,014
    
    
    
    1,058,898
    
    
    
    1,058,898
    
    
    
    1,303,631
    
    
    
    1,303,631Total assets
    
    
    488,164,862
    
    
    
    476,698,066
    
    
    
    429,557,096
    
    
    
    417,329,141
    
    
    
    385,842,184
    
    
    
    373,975,135Current liabilities (2),(6)
    
    
    146,214,601
    
    
    
    173,164,195
    
    
    
    167,192,503
    
    
    
    188,187,731
    
    
    
    142,197,050
    
    
    
    141,659,692Accrued financing costs
    
    
    1,087,500
    
    
    
    1,087,500
    
    
    
    921,109
    
    
    
    921,109
    
    
    
    863,329
    
    
    
    863,329Long term debt(6)
    
    
    222,007,309
    
    
    
    236,007,431
    
    
    
    111,352,141
    
    
    
    110,536,000
    
    
    
    86,608,830
    
    
    
    86,608,830Non-controlling interest(7)
    
    
    5,759,206
    
    
    
    5,416,831
    
    
    
    6,023,149
    
    
    
    5,682,695
    
    
    
    6,404,262
    
    
    
    6,063,971Shareholders
equity (1),(2),(4),(5),(6)
    
    
    113,096,246
    
    
    
    61,022,109
    
    
    
    144,068,194
    
    
    
    112,001,606
    
    
    
    149,768,713
    
    
    
    138,779,313Total liabilities and
shareholders equity
    
    
    488,164,862
    
    
    
    476,698,066
    
    
    
    429,557,096
    
    
    
    417,329,141
    
    
    
    385,842,184
    
    
    
    373,975,135
 (1)
    
    OperationsThe Company determined that refinery
operations commenced under U.S. GAAP at
December 1, 2004, which is the date
management assessed that construction of the
refinery was substantially complete and
ready for its intended use. The Company
ceased capitalization of certain costs to
the refinery project at this date and
recognized one months results from sales,
related costs of sales and operating
expenses and administrative and general
expenses in the statement of operations for
the year ended December 31, 2004.As disclosed in note 2(q) in the
consolidated financial statements,
operations commenced on January 1, 2005
under Canadian GAAP. Therefore, the Company
continued to capitalize December 2004s
results to the refinery project. Due to the
difference in the cost basis of the
refinery, the depreciation expense recorded
under U.S. GAAP differs from that recorded
under Canadian GAAP during 2005.In the prior year, in addition to
recognizing December 2004s results in the
statement of operations, one month of
depreciation expense was also recorded
under U.S. GAAP for the refinery during
2004. The useful life for the refinery
under U.S. GAAP is the same as that
disclosed under Canadian GAAP in note 2(q)
in the consolidated financial statements.(2)
    
    Derivative instruments and hedgingThe Company accounts for derivatives and
hedging activities in accordance with
FASB Statement No. 133, Accounting for
Derivative Instruments and Certain
Hedging Activities, as amended (SFAS No.
133), which requires that all derivative
instruments be recorded on the balance
sheet at their respective fair values.The Canadian Institute of Chartered
Accountants issued Accounting Guideline 13
Hedging Relationships (AcG-13), which
became effective January 1, 2004. This
guideline was issued to align certain
accounting principles under Canadian GAAP
with SFAS No. 133, including hedge
documentation and assessing hedge
effectiveness.The Company adopted the hedge
accounting provisions in
AcG-13 and SFAS No. 133 in respect of the
commodity forward contracts it transacted
beginning in July 2004. Under Canadian GAAP,
the Company includes hedges which are
unsettled at period end in current
liabilities based on a marked to market
calculation. Under SFAS No. 133 the marked
to market amount for the unsettled hedges is
included in other comprehensive income to
the extent that they are effective. The
ineffective portion is expensed. Details of
hedge accounting is disclosed in notes 2(o)
and 7 in the consolidated financial
statements of the Company for the year ended
December 31, 2006.(3)
    
    Income tax effect of adjustmentsThe income tax effect of U.S. GAAP
adjustments was an addition to the future
tax asset of $6,871,557 (2005  reduction
of $1,497,267) for the year ended December
31, 2006 due to an increase in the loss
carry-forwards. A corresponding decrease in
the valuation allowance was recorded. No
income tax expense was recorded in the
years ended December 31, 2006, 2005 and
2004 due to the tax holiday period in Papua
New Guinea through five years after the
refinery commences operations.
 INTEROIL 2006      110




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(4)
    
    Stock based compensationAt January 1, 2004, the Company adopted the
provisions of CICA 3870 in respect of the
employee stock-based awards, which resulted
in recognition of compensation expense for
such awards under Canadian GAAP on a basis
consistent with the fair value provisions
of SFAS No. 123. As disclosed in note 2(t)
to the consolidated financial statements,
the Company retroactively applied the fair
value method to all employee stock options
granted on or after January 1, 2002,
without restatement to prior years.This is
not consistent with the modified
prospective transition method allowed for a
voluntary change to the fair value method
under FASB Statement No. 148 Accounting
for Stock-Based Compensation  Transition
and Disclosure, an amendment of FASB
Statement No. 123 (SFAS No. 148). The
modified prospective method requires
retroactive consideration of all employee
stock awards granted, modified or settled
on or after January 1, 1995. The Company
did not adjusted for this GAAP difference
as there were no options granted, modified
or settled between January 1, 1995 and
January 1, 2002 that would have materially
impacted net income for the years ended
December 31, 2005, 2004 and 2003.The cumulative effect of this change in
accounting principle of $737,650 was
recorded to opening accumulated deficit
under Canadian GAAP. This is required to be
disclosed as a cumulative change in
accounting principle in the statement of
operations under U.S. GAAP.(5)
    
    Debt conversion expenseAs disclosed in note 22 in the
consolidated financial statements, 100% of
the convertible debentures were converted
before December 31, 2004. The Company
issued an additional 180,000 shares to
induce conversion before the end of the
year. Under Canadian GAAP, the fair value
of these shares was recorded as an
increase in share capital of $6,976,800
with offsetting adjustments to retained
earnings of $6,899,211 and a conversion
expense of $77,589.FASB Statement No. 84, Induced
Conversions of Convertible Debt requires
an expense to be recorded when convertible
debt is converted under an inducement. The
Company recognized the entire fair value
of the inducement shares of $6,976,800 as
a conversion expense under U.S. GAAP.(6)
    
    Indirect participation interestAs disclosed in note 18 in the consolidated
financial statements, the Company entered
into an indirect participation interest
agreement in exchange for proceeds of
$125,000,000. Under Canadian GAAP, this
amount was apportioned between non
financial liabilities and equity.EITF
00-19 Accounting for derivatives indexed
to and potentially settled in a Companys
own stock requires the conversion options
to be treated as a current liability. As a
result, the conversion options should be
adjusted to their fair market value on the
reporting date.As such the Company has recognised a loss
on the revaluation of conversion options
totalling $19,755,017 (2005  gain of
$4,279,284) at December 31, 2006.Under
Canadian GAAP, the Company split
$8,138,742 of transaction costs relating
to the indirect participation
interest agreement between the indirect
participation interest liability
($6,364,523) and the conversion options
($1,774,219). Under US GAAP the full amount
of $8,138,742 has been allocated to the
indirect participation interest liability.(7)
    
    Non controlling interestThe non-controlling interest movements
are the result of the US GAAP adjustments
relating to the midstream operations
described in points 1 to 4 above.
 111      INTEROIL 2006




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(1)
    
    Financial data for the year ended
December 31, 2004 represents results for the
period from January 1, 2004 to April 28,
2004, the effective date the Company gained
control of IPL, and is derived from the
unaudited management accounts of IPL.
Financial data for the year ended December
31, 2003 represents the actual results for
the year ended December 31, 2003.(2)
    
    The weighted average number of shares used in the earnings per share information is consistent
with that used under Canadian GAAP for the respective periods.(3)
    
    The weighted average number of shares used in the earnings per share information is consistent
with that used under U.S. GAAP for the respective periods.
    Twelve months ended December 31, 2004
    
    InterOil (audited)
    
    IPL(1)(unaudited)
    
    Pro forma (unaudited)Sales and operating revenue  Canadian GAAP
    
    
    70,644,486
    
    
    
    27,317,000
    
    
    
    97,961,486Sales and operating revenue  US GAAP
    
    
    121,974,268
    
    
    
    27,317,000
    
    
    
    149,291,268Net profit/(loss)  Canadian GAAP
    
    
    (52,939,881
    )
    
    
    2,350,000
    
    
    
    (50,589,881
    )Net profit/(loss)  U.S. GAAP
    
    
    (75,307,371
    )
    
    
    2,350,000
    
    
    
    (72,957,371
    )Basic loss per share (cents per share)Canadian GAAP (2)
    
    
    (208
    )
    
    
    
    
    
    
    (199
    )U.S. GAAP (3)
    
    
    (297
    )
    
    
    
    
    
    
    (287
    )Diluted loss per share (cents per share)Canadian GAAP (2)
    
    
    (208
    )
    
    
    
    
    
    
    (199
    )U.S. GAAP (3)
    
    
    (297
    )
    
    
    
    
    
    
    (287
    )
 Twelve months ended December 31, 2003
    
    InterOil (audited)
    
    IPL(1)(unaudited)
    
    Pro forma (unaudited)Sales and operating revenue  Canadian and U.S. GAAP
    
    
    
    
    
    
    69,897,000
    
    
    
    69,897,000Net profit/(loss)  Canadian GAAP
    
    
    (3,517,569
    )
    
    
    6,474,000
    
    
    
    2,956,431Net profit  U.S. GAAP
    
    
    4,435,965
    
    
    
    6,474,000
    
    
    
    10,909,965Basic earnings/(loss) per share (cents per share)Canadian GAAP (2)
    
    
    (15
    )
    
    
    
    
    
    
    14U.S. GAAP (3)
    
    
    20
    
    
    
    
    
    
    
    49Diluted earnings/(loss) per share (cents per share)Canadian GAAP (2)
    
    
    (15
    )
    
    
    
    
    
    
    13U.S. GAAP (3)
    
    
    18
    
    
    
    
    
    
    
    45
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INTEROIL 2006 114




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115      INTEROIL 2006




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Directors
 
 Officers
 Chairman, Chief Executive
Officer, and President
 Member of the Board,
Executive Vice President
Head of Corporate Development
and Government Affairs
 Vice President Investor
and Public Relations
 General Manager
Wholesale and Retail Distribution
 General Manager
Exploration and Production
 President
and Chief Operating Officer
 General
Manager Supply and Trading
 Chief Financial
Officer
 Stock Exchanges
 Canada
 
 United States
 
 Papua New Guinea
 Legal
 Canada
 
 Australia and Papua
 New Guinea
 
 United States
 
 Bankers
 Canada
 
 United States
 
 Papua New Guinea
 
 Web
 Auditors
 Share Registrars
 Canada
 
 Operational Office
Locations
 Cairns
 
 Houston
 
 Port Moresby
 
 Registered Office
Location
 Canada
 
 Email
 INTEROIL 2006      116




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