UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    Form 10-Q



(Mark one)

[X]      Quarterly  Report Under Section 13 or 15(d) of The Securities  Exchange
         Act of 1934

                              For the quarterly period ending September 30, 2006

[_]      Transition Report Under Section 13 or 15(d) of The Securities  Exchange
         Act of 1934

                  For the transition period from ______________ to _____________



                         Commission File Number: 0-29613
                                                 -------

                         TIDELANDS OIL & GAS CORPORATION
        (Exact name of small business issuer as specified in its charter)

         Nevada                                                 66-0549380
------------------------                                ------------------------
(State of incorporation)                                (IRS Employer ID Number)

                  1862 West Bitters Rd., San Antonio, TX 78248
                  --------------------------------------------
                    (Address of principal executive offices)

                                 (210) 764-8642
                                 --------------
                           (Issuer's telephone number)



      Securities registered under Section 12 (b) of the Exchange Act: None

         Securities registered under Section 12(g) of the Exchange Act:
                         Common Stock - $0.001 par value



Check  whether  the issuer  has (1) filed all  reports  required  to be files by
Section 13 or 15(d) of the  Exchange  Act during the past 12 months (or for such
shorter period the Company was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days. Yes X No

Indicate by check mark whether the registrant is a large  accelerated  filer, an
accelerated  filer, or a non-accelerated  filer. See definitions of "accelerated
filer and large  accelerated  filer in Rule 12b-2 of the  Exchange  Act.  (Check
one):
Large accelerated filer   , Accelerated filer   , Non-accelerated filer X
                       ---                   ---                       ---

Indicate by check mark whether the  registrant is a shell company (as defined by
Rule 12b-2of the Exchange Act. Yes    No X
                                  ---   ---

                      APPLICABLE ONLY TO CORPORATE ISSUERS

As of September 30, 2006,  there were  84,537,270  shares of Common Stock issued
and outstanding.

Transitional Small Business Disclosure Format: Yes    No X
                                                  ---   ---




<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
                                    FORM 10-Q


                                      INDEX

                                                                            Page
PART I - Financial Information

Item 1 - Financial Statements
         Condensed Consolidated Balance Sheets as of
         September 30, 2006 and December 31, 2005.........................     3

         Condensed Consolidated Statements of Operations
         For the Three Months Ended September 30, 2006 and 2005...........     4

         Condensed Consolidated Statements of Operations
         For the Nine Months Ended September 30, 2006 and 2005............     5

         Condensed Consolidated Statements of Cash Flows
         For the Nine Months Ended September 30, 2006 and 2005............   6-7

         Notes to Condensed Consolidated Financial Statements.............  8-14

Item 2 - Management's Discussion and Analysis of Financial Condition
         and Results of Operations........................................

Item 3 - Quantitative and Qualitative Disclosures About Market Risk.......

Item 4 - Controls and Procedures..........................................


PART II - Other Information

Item 1 - Legal Proceedings ...............................................

Item 1A. Risk Factors.....................................................

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds......

Item 3 - Defaults Upon Senior Securities..................................

Item 4 - Submission of Matters to a Vote of Security Holdings.............

Item 5 - Other Information................................................

Item 6 - Exhibits ........................................................

Signature.................................................................






                                       -2-


<PAGE>
<TABLE>
<CAPTION>


                         PART I - FINANCIAL INFORMATION

Item 1.     Financial Statements

                         TIDELANDS OIL & GAS CORPORATION
                      CONDENSED CONSOLIDATED BALANCE SHEETS

                                     ASSETS

                                                      September 30,     December 31,
                                                           2006             2005
                                                      -------------    -------------
                                                       (Unaudited)
<S>                                                   <C>              <C>
Current Assets:
   Cash and Cash Equivalents                          $     887,194    $   1,113,911
   Accounts and Loans Receivable                            290,968          468,458
   Inventory                                                 74,589          142,204
   Prepaid Expenses                                         312,918          183,938
                                                      -------------    -------------
      Total Current Assets                                1,565,669        1,908,511
                                                      -------------    -------------

Property Plant and Equipment, Net                        12,226,640       10,042,088
                                                      -------------    -------------

Due from Related Party                                      283,854          288,506
                                                      -------------    -------------

Other Assets:
   Deposits                                                  64,004           14,004
   Restricted Cash                                           52,159           76,803
   Deferred Charges                                         880,256                0
   Goodwill                                               1,158,937        1,158,937
                                                      -------------    -------------
      Total Other Assets                                  2,155,356        1,249,744
                                                      -------------    -------------

      Total Assets                                    $  16,231,519    $  13,488,849
                                                      =============    =============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities:
   Current Maturities - Notes Payable                 $     225,000    $     225,000
   Accounts Payable and Accrued Expenses                  1,000,176        1,225,554
                                                      -------------    -------------
      Total Current Liabilities                           1,225,176        1,450,554

Long-Term Debt                                           10,014,752        4,271,768
                                                      -------------    -------------

      Total Liabilities                                  11,239,928        5,722,322
                                                      -------------    -------------

Commitments and Contingencies                                  --               --

Stockholders' Equity:
   Common Stock, $.001 Par Value per Share,
     250,000,000 Shares Authorized, 84,537,270
     and 78,495,815 Shares Issued and
     Outstanding at September 30, 2006
     and December 31, 2005 Respectively                      84,538           78,497
   Paid-in Capital in Excess of Par Value                45,250,456       40,818,174
   Subscriptions Receivable                                (330,000)        (550,000)
   Minority Interest                                           --               --
   Accumulated (Deficit)                                (40,013,403)     (32,580,144)
                                                      -------------    -------------
      Total Stockholders' Equity                          4,991,591        7,766,527
                                                      -------------    -------------

      Total Liabilities and Stockholders' Equity      $  16,231,519    $  13,488,849
                                                      =============    =============
</TABLE>




      See Accompanying Notes to Condensed Consolidated Financial Statements
                                       -3-


<PAGE>
<TABLE>
<CAPTION>

                         TIDELANDS OIL & GAS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)



                                            Three Months Ended    Three Months Ended
                                            September 30, 2006    September 30, 2005
                                            ------------------    -----------------
                                                                      (Restated)
<S>                                         <C>                   <C>
Revenues:
   Gas Sales and Pipeline Fees              $          355,937    $         248,015
   Construction Services                                13,289                    0
                                            ------------------    -----------------
      Total Revenues                                   369,226              248,015
                                            ------------------    -----------------

Expenses:
   Cost of Sales                                       176,675              219,865
   Operating Expenses                                  102,010               81,408
   Depreciation                                        114,085              124,422
   Interest                                          2,572,249              110,090
   Beneficial Conversion Feature Interest                    0             (637,448)
   Sales, General and Administrative                 1,229,528            1,901,401
                                            ------------------    -----------------

      Total Expenses                                 4,194,547            1,799,738
                                            ------------------    -----------------

(Loss) From Operations                              (3,825,321)          (1,551,723)

Derivative Gain (Loss)                                       0                    0
(Loss) on Sale of Investments                             (743)                   0
(Loss) on Sale of Equipment                             (4,500)                   0
Interest and Dividend Income                            53,500               26,589
Litigation Settlement                                        0              297,825
                                            ------------------    -----------------

Net Income (Loss)                           $       (3,777,064)   $      (1,227,309)
                                            ==================    =================

Net Income (Loss) Per Common Share:
   Basic and Diluted                        $            (0.05)   $           (0.02)
                                            ==================    =================

Weighted Average Number of Common
   Shares Outstanding                               82,551,543           75,712,742
                                            ==================    =================
</TABLE>









      See Accompanying Notes to Condensed Consolidated Financial Statements
                                       -4-


<PAGE>
<TABLE>
<CAPTION>

                         TIDELANDS OIL & GAS CORPORATION
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)




                                             Nine Months Ended     Nine Months Ended
                                            September 30, 2006    September 30, 2005
                                            ------------------    ------------------
                                                                      (Restated)
<S>                                         <C>                   <C>
Revenues:
   Gas Sales and Pipeline Fees              $        1,420,551    $        1,097,505
   Construction Services                               157,693               119,121
                                            ------------------    ------------------
   Total Revenues                                    1,578,244             1,216,626
                                            ------------------    ------------------



Expenses:
   Cost of Sales                                       759,954               635,113
   Operating Expenses                                  286,128               210,545
   Depreciation                                        345,887               360,817
   Interest                                          3,057,258               503,950
   Beneficial Conversion Feature Interest                    0              (501,659)
   Sales, General and Administrative                 4,672,273             6,578,471
   Impairment Losses                                         0             5,200,000
                                            ------------------    ------------------
      Total Expenses                                 9,121,500            12,987,237
                                            ------------------    ------------------

(Loss) From Operations                              (7,543,256)          (11,770,611)

Derivative Gain (Loss)                                       0             5,168,000
(Loss) on Sale of Investments                             (743)                    0
(Loss) on Sale of Equipment                             (4,500)               (3,167)
Interest and Dividend Income                           115,239                96,240
Litigation Settlement                                        0               297,825
                                            ------------------    ------------------

Net (Loss)                                  $       (7,433,260)   $       (6,211,713)
                                            ==================    ==================

Net (Loss) Per Common Share:
   Basic and Diluted                        $            (0.09)   $            (0.09)
                                            ==================    ==================

Weighted Average Number of Common
   Shares Outstanding                               81,516,543            69,378,850
                                            ==================    ==================
</TABLE>




      See Accompanying Notes to Condensed Consolidated Financial Statements
                                       -5-


<PAGE>
<TABLE>
<CAPTION>

                         TIDELANDS OIL & GAS CORPORATION
                 STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
                                   (UNAUDITED)




                                                   Nine Months Ended     Nine Months Ended
                                                  September 30, 2006    September 30, 2005
                                                  ------------------    ------------------
                                                                             (Restated)
<S>                                               <C>                   <C>
Cash Flows Provided (Required) By
  Operating Activities:
     Net (Loss)                                   $       (7,433,260)   $       (6,211,713)
     Adjustments to Reconcile Net (Loss)
      to Net Cash Provided (Required) By
      Operating Activities:
         Depreciation                                        314,666               360,817
         Loss on Disposal of Equipment                         4,500                 3,167
         Change in Derivative Liability                            0            (5,168,000)
         Issuance of Common Stock:
           For Services Provided                           1,910,800             3,682,950
           For Payment of Interest                         1,696,982                     0
         Beneficial Conversion Feature Interest                    0              (501,659)
         Changes in:
           Accounts Receivable                               177,490               307,719
           Inventory                                          67,615                (7,809)
           Prepaid Expenses                                 (128,980)              278,609
           Deferred Charges                                 (880,256)              116,250
           Deposits                                          (50,000)               (2,600)
           Restricted Cash                                    24,644              (101,471)
           Accounts Payable and
             Accrued Expenses                                219,622                68,233
           Impairment Losses                                       0             5,200,000
                                                  ------------------    ------------------

Net Cash (Required) By Operating Activities               (4,076,177)           (1,975,507)
                                                  ------------------    ------------------

Cash Flows Provided (Required)
  By Investing Activities:
    Acquisitions of Property, Plant
         and Equipment                                    (2,525,218)           (1,376,250)
    Disposals of Equipment                                    21,500                   800
                                                  ------------------    ------------------

Net Cash (Required) By Investing Activities               (2,503,718)           (1,375,450)
                                                  ------------------    ------------------
</TABLE>









      See Accompanying Notes to Condensed Consolidated Financial Statements
                                       -6-


<PAGE>
<TABLE>
<CAPTION>

                         TIDELANDS OIL & GAS CORPORATION
                 STATEMENTS OF CONDENSED CONSOLIDATED CASH FLOWS
                                   (CONTINUED)

                                   (UNAUDITED)



                                                Nine Months Ended     Nine Months Ended
                                               September 30, 2006    September 30, 2005
                                               ------------------    ------------------
                                                                        (Restated)
<S>                                            <C>                   <C>
Cash Flows Provided (Required)
   by Financing Activities:
      Proceeds from Stock Subscriptions
        Receivable                                        220,000                     0
      Proceeds from Long-Term Loans                     6,737,276               201,671
      Repayment of Long-Term Loans                       (608,750)                    0
      Repayment of Loan by Related Party                    4,652                 1,662
                                               ------------------    ------------------

Net Cash Provided by Financing Activities               6,353,178               203,333
                                               ------------------    ------------------

Net (Decrease) in Cash                                   (226,717)           (3,147,624)

Cash at Beginning of Period                             1,113,911             5,484,054
                                               ------------------    ------------------

Cash at End of Period                          $          887,194    $        2,336,430
                                               ==================    ==================

Supplemental Disclosures of
   Cash Flow Information:
       Cash Payments for Interest              $        1,153,116    $          266,938
                                               ==================    ==================

       Cash Payments for Income Taxes          $                0    $                0
                                               ==================    ==================

Non-Cash Investing and Financing Activities:
   Issuance of Common Stock:
      Repayment of Note                        $                0    $        2,512,500
      Repayment of Convertible Debentures                 385,542             4,020,000
      Payment of Accrued Expense                          445,000                     0
                                               ------------------    ------------------

      Total Non-Cash Investing and
         Financing Activities                  $          830,542    $        6,532,500
                                               ==================    ==================
</TABLE>










      See Accompanying Notes to Condensed Consolidated Financial Statements
                                       -7-

<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 2006


NOTE 1 - BASIS OF PRESENTATION
------   ---------------------

         The accompanying  unaudited condensed consolidated financial statements
         for the nine month periods ended  September  30, 2006,  and 2005,  have
         been  prepared  in  conformity  with  accounting  principles  generally
         accepted  in  the  United  States  of  America  for  interim  financial
         information and with the  instructions to Form 10-Q and Regulation S-X.
         The financial  information as of December 31, 2005, is derived from the
         registrant's  Form 10-K for the year ended  December 31, 2005.  Certain
         information  or footnote  disclosures  normally  included in  financial
         statements prepared in accordance with accounting  principles generally
         accepted in the United States of America have been condensed or omitted
         pursuant to the rules and  regulations  of the  Securities and Exchange
         Commission.

         The  preparation  of condensed  consolidated  financial  statements  in
         conformity with accounting  principles generally accepted in the United
         States of America requires management to make estimates and assumptions
         that affect the reported  amounts of assets and liabilities at the date
         of the financial  statements  and the reported  amounts of revenues and
         expenses during the reporting period.  Actual results could differ from
         those  estimates.  In  the  opinion  of  management,  the  accompanying
         financial statements include all adjustments  necessary (which are of a
         normal and recurring  nature) for the fair  presentation of the results
         of the interim periods  presented.  While the registrant  believes that
         the  disclosures  presented are adequate to keep the  information  from
         being  misleading,  it is suggested that these  accompanying  financial
         statements  be  read  in  conjunction  with  the  registrant's  audited
         consolidated financial statements and notes for the year ended December
         31,  2005,  included in the  registrant's  Form 10-K for the year ended
         December 31, 2005.

         Operating  results for the nine-month  period ended September 30, 2006,
         are not necessarily  indicative of the results that may be expected for
         the  remainder  of the  fiscal  year  ending  December  31,  2006.  The
         accompanying  unaudited  condensed  consolidated  financial  statements
         include the accounts of the registrant,  its wholly-owned subsidiaries,
         Rio Bravo Energy, LLC, Sonora Pipeline, LLC, Arrecefe Management,  LLC,
         Marea Associates, LP, Reef Ventures, LP, Reef International,  LLC, Reef
         Marketing,  LLC,  Terranova  Energia  S. de R. L. de C.  V.,  Esperanza
         Energy, LLC, and Tidelands  Exploration & Production  Corporation.  All
         significant   inter-company   accounts  and   transactions   have  been
         eliminated in consolidation.








                                       -8-

<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 2006




NOTE 2 - GOING CONCERN
------   -------------

         The Company has sustained recurring losses and negative cash flows from
         operations.  Over the past year,  the Company's  growth has been funded
         through issuance of convertible  debentures.  As of September 30, 2006,
         the Company had approximately  $900,000 of unrestricted cash.  However,
         the  Company has  experienced  and  continues  to  experience  negative
         operating  margins and negative cash flows from operations,  as well as
         an ongoing  requirement for substantial  additional capital investment.
         The Company expects that it will need to raise  substantial  additional
         capital to accomplish  its business  plan over the next several  years.
         The  Company is  seeking  to obtain  such  additional  funding  through
         private equity sources, possible sale of certain operating assets along
         with reduction of operating  expenses.  There can be no assurance as to
         the  availability  or terms upon which such financing and capital might
         be available or that asset sales will be possible at suitable pricing.

NOTE 3 - LITIGATION
------   ----------

         On January 6, 2003,  we were  served as a third  party  defendant  in a
         lawsuit titled  Northern  Natural Gas Company vs. Betty Lou Sheerin vs.
         Tidelands Oil & Gas Corporation, ZG Gathering, Ltd. and Ken Lay, in the
         150th  Judicial  District  Court,  Bexar  County,  Texas,  Cause Number
         2002-C1-16421.  The  lawsuit  was  initiated  by  Northern  Natural Gas
         (Northern) when it sued Betty Lou Sheerin  (Sheerin) for her failure to
         make  payments  on a note  she  executed  payable  to  Northern  in the
         original  principal  amount of $1,950,000.  Sheerin's  answer generally
         denied  Northern's  claims  and  raised  the  affirmative  defenses  of
         fraudulent  inducement  by Northern,  estoppel,  waiver and the further
         claim that the note does not comport with the legal  requirements  of a
         negotiable instrument. Sheerin seeks a judicial ruling that Northern be
         denied  any  recovery  on  the  note.   Sheerin's   answer  included  a
         counterclaim  against  Northern,  ZG  Gathering,   Ltd.,  and  Ken  Lay
         generally alleging,  among other things,  that Northern,  ZG Gathering,
         Ltd ., and Ken Lay,  fraudulently  induced her  execution  of the note.
         Northern  has  filed  a  general  denial  of  Sheerin's  counterclaims.
         Sheerin's  answer included a third party cross claim against  Tidelands
         Oil and Gas Corporation (Tidelands). She alleges that Tidelands entered
         into an  agreement  to  purchase  the Zavala  Gathering  System from ZG
         Gathering, Ltd., and that, as a part of the agreement, Tidelands agreed
         to satisfy all of the  obligations  due and owing to Northern,  thereby
         relieving  Sheerin  of  all  obligations  she  had to  Northern  on the
         $1,950,000  promissory  note in  question.  Tidelands  participated  in
         mediation  on March 11,  2003.  The case was not  settled at that time.
         Tidelands' answer denies all of Sheerin's allegations.

         Betty Lou Sheerin filed amended pleadings, wherein she sued current and
         former  Tidelands'  Board members,  Michael Ward,  Royis Ward, James B.
         Smith, Carl Hessel and Ahmed Karim in their individual capacities.  Her
         claims  against these  individuals  are for fraud,  breach of contract,
         breach of the Uniform Commercial Code, breach of duty of good faith and
         fair  dealing and  conversion.  Sheerin has now  non-suited  her claims
         against Michael Ward, Royis Ward and James B. Smith.

         In September 2002, the Company  executed a $300,000  promissory note to
         Betty L.  Sheerin,  a partner of ZG  Gathering,  Ltd. In addition,  the
         Company issued 1,000,000 shares of its common stock to various partners
         of ZG  Gathering,  Ltd. On December 3, 2003,  Sheerin  filed a separate
         lawsuit against Tidelands in Bexar County, Texas on this note seeking a
         judgment  against  Tidelands for the principle amount of the note, plus
         interest.  Tidelands  answered  this lawsuit  denying  liability on the
         note.  The  Company  believes  that the  promissory  note and shares of
         common  stock  should  be  cancelled  based  upon  the  outcome  of the
         litigation  described  above.  Accordingly,  our  financial  statements
         reflect this belief.


                                       -9-

<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 2006


NOTE 3 - LITIGATION (CONTINUED)
------   ----------------------

         In September,  and again in October 2004, Sheerin amended her pleadings
         regarding the third party cross action against Tidelands adding a claim
         for the  $300,000  promissory  note.  Sheerin  also  deleted her claims
         against Carl Hessel and Ahmed Karim (Company Directors).

         Tidelands won a partial summary  judgment  against Sheerin as to all of
         her tort claims pled against Tidelands,  save and except only her claim
         for conversion of 500,000 shares of Tidelands' stock.

         Sheerin  seeks  damages  against  Tidelands  for indemnity for any sums
         found to be due from her to  Northern,  unspecified  amounts  of actual
         damages,  statutory damages,  unspecified amounts of exemplary damages,
         attorneys  fees,  costs  of suit,  and  prejudgment  and post  judgment
         interest.

         On August 5, 2005,  Northern,  for the first time, named Tidelands as a
         defendant to Northern.  Northern seeks to impose liability on Tidelands
         for $1,950,000  promissory note signed by McDay Energy  Partners,  Ltd.
         (the predecessor to ZG Gathering,  Ltd.) and Sheerin and the $1,700,000
         promissory note signed by McDay only.  Northern contends that Tidelands
         is alternatively liable to Northern for payment of both such promissory
         notes  totaling   $3,709,914  plus  interest   because  Northern  is  a
         third-party  beneficiary  under a December 3, 2001,  purchase  and sale
         agreement  between ZG Gathering,  Ltd., and Tidelands  claiming that in
         such agreement  Tidelands agreed to assume and satisfy all indebtedness
         due and owing Northern by Sheerin and ZG Gathering,  Ltd. Northern also
         claims  that  it is  entitled  to  foreclosure  of a lien  on  the  gas
         gathering  system and pipeline  that was the subject of the  promissory
         notes in question.

         On March 6,  2006,  Tidelands  won a summary  judgment  motion it filed
         against  Northern  and the court has now  dismissed  Northern's  claims
         against Tidelands.

         On November 28, 2005,  ZG  Gathering,  Ltd. and ZG Pipeline  Management
         ("ZG") filed its answer to its counter-claim against Northern,  and its
         answer  and  cross  claim  against  Tidelands.  ZG  contends  that  the
         promissory  notes given by ZG and Sheerin to Northern  were procured by
         Northern's  fraudulent  misrepresentations  and it  claims  unspecified
         amounts  of  damages  against  Northern.   ZG's  cross  action  against
         Tidelands  claims that Tidelands  entered into an agreement to purchase
         the  Zavala  Gathering  System  from  ZG and  that,  as  part  of  that
         agreement,   Tidelands  agreed  to  satisfy  the  $3,700,914   Northern
         indebtedness of ZG, and to defend,  indemnify,  and hold ZG and Sheerin
         harmless from such  indebtedness to pay off a Sheerin loan of $300,000,
         and to issue 1 million shares of Tidelands' stock, of which 500,000 was
         to be  free-trading  shares.  ZG claims that  Tidelands  breached  this
         agreement. ZG seeks specific performance of the agreement,  recovery of
         an unspecified amount of damages, and its attorney's fees.


                                      -10-


<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 2006


NOTE 3 - LITIGATION (CONTINUED)
------   ----------------------

         Much of the  discovery  has  been  completed  at this  time.  Based  on
         investigation,  and  discovery  to date,  Tidelands  appears  to have a
         number of  potential  defenses to the claims of Sheerin  and  Northern.
         Tidelands intends to aggressively defend these lawsuits. The complexity
         of the issues in this case and the inherent uncertainties in litigation
         of this kind  prevent a more  definitive  evaluation  of the  extent of
         Tidelands' liability exposure.

         During April and May, 2005, three separate legal actions were initiated
         against  Sonterra  Energy   Corporation   (Sonterra),   a  wholly-owned
         subsidiary of the Company.  Two of the actions  concern  claims made by
         developers  against Sonterra for their failure to pay rent and easement
         use fees as a  result  of  their  asset  purchase  from  Oneok  Propane
         Distribution  Company on November 1, 2004. The third action  involves a
         claim made by a builder that Sonterra  does not have a proper  easement
         for the current use of certain property.  The Company believes that the
         three actions  filed are without merit and intend to vigorously  defend
         itself.  Litigation  regarding  these three  actions are still in their
         early stages, therefore, potential financial impacts, if any, cannot be
         determined at this time.

         In accordance with Statement of Financial  Accounting  Standards No. 5,
         "Accounting for  Contingencies,"  management has reached the conclusion
         that   there  is  a  remote   possibility   that  any  or  all  of  the
         aforementioned  claims would be upheld at trial and has also determined
         that  the  amount  of  the  claims  cannot  be  reasonably   estimated.
         Accordingly, the Company's financial statements reflect no accrual of a
         loss contingency with response to the above legal matters.

NOTE 4 - COMMON STOCK TRANSACTIONS
------   -------------------------

         On August 6, 2006,  the  Company  issued  100,000  shares of its common
         stock valued at $63,500 to an employee of the Company.

         On September 18, 2006,  the Company issued 349,856 shares of its common
         stock to a holder  of its  Convertible  Debentures  for  conversion  of
         $304,375.

         On September 25, 2006,  the Company  issued 93,295 shares of its common
         stock to a holder  of its  Convertible  Debentures  for  conversion  of
         $81,167.

         On  September  25,  2006,  the  Company  issued  150,000  shares of its
         restricted  common  stock  valued at $87,000 to three  Directors  for a
         total of 450,000 common shares valued at $261,000.




                                      -11-


<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 2006


NOTE 4 - COMMON STOCK TRANSACTIONS (CONTINUED)
------   -------------------------------------

         On September 25, 2006,  the Company issued 150,000 shares of its common
         stock valued at $87,000 to a fourth Director.

         On  September  28, 2006,  the Company  issued  2,828,304  shares of its
         restricted common stock valued at $1,696,982 to five investors in order
         to cure all existing  events of default in accordance with the terms of
         a Waiver and Amendment Agreement relating to the Convertible Debentures
         they previously acquired (See NOTE 5 - Debt Financing).


NOTE 5 - RELATED PARTY TRANSACTION
------   -------------------------

         The Company  executed an agreement in January 2004 with a related party
         to provide charter air transportation for its employees,  customers and
         contractors to job sites and other  business  related  destinations.  A
         $300,000 5% interest  bearing  loan due in January 2007 was made by the
         Company  regarding  the  transaction.  The loan  balance is credited by
         airtime charges at standard  industry rates offset by interest  charges
         computed on the average  monthly  balance.  At September 30, 2006,  the
         loan balance was $283,854.

         During 2006,  the  President  acquired the airplane  being  utilized to
         provide charter air  transportation for the Company which is being held
         by his wholly-owned corporation. The transaction includes assumption of
         the  $300,000  5%  interest  bearing  loan due in  January  2007 to the
         Company.

         On July 9,  2006,  the  Company  acquired a 50%  interest  in a 24-mile
         natural gas pipeline located in Medina,  Atascosa and Bexar Counties in
         the state of Texas. In addition, the Company also acquired an undivided
         50% working interest in two leases with 5 recompleted natural gas wells
         on  approximately  1,000 acres with at least 10 additional  natural gas
         wells for  re-entry.  These  leases are located in Atascosa  and Medina
         counties.  The Company  expects to participate in acquiring  additional
         leases  which  could  be  developed  around  the area  serviced  by the
         pipelines. Total consideration for these transactions is $500,000 which
         is being paid to a related party.











                                      -12-


<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 2006


NOTE 6 - DEBT FINANCING
------   --------------

         On January 20,  2006,  the Company  completed  a private  placement  of
         $6,569,750 of convertible debt with seven institutional  investors. The
         net proceeds realized by the Company were $4,949,291 after deduction of
         legal costs,  commission  and  interest  discount.  The Company  issued
         original issue discount  debentures with a maturity date of January 20,
         2008, and a conversion  feature which  permitted the holders to convert
         into  common  stock of the  Company at a price of $0.87 per share.  The
         investors also received three year "Series A Common Stock  Warrants" to
         purchase,  in the  aggregate,  2,491,975  shares of common stock of the
         Company at a conversion  price of $0.935 per share.  Additionally,  the
         Company issued to the investors  "Series B Common Stock Warrants" which
         provided for a thirteen month exercise period, at a conversion price of
         $1.275 per share,  and an aggregate  purchase total of 7,551,432 shares
         of common stock of the Company.

         In accordance with this private  placement,  the Company entered into a
         "Registration  Rights  Agreement"  with the investors,  whereby,  among
         other  terms and  conditions,  the Company  must  comply  with  various
         effective  dates and  periods  or, if in default  of said dates  and/or
         periods,  be subject to  liquidated  damages as  outlined in the master
         agreement.  Between June 2006 and  September  22, 2006,  the  investors
         billed and were paid $478,155 of liquidated  damages including $182,625
         paid to RHP Master Fund,  Ltd., as described  below for not meeting the
         required effective date.

         On September 20, 2006, RHP Master Fund,  Ltd.  ("RHP") gave the Company
         its notice of default  for  failure  to timely pay  liquidated  damages
         associated with the Company's failure to timely register the underlying
         debenture   shares  and  warrants  with  the  Securities  and  Exchange
         Commission.  RHP  accelerated  payment  of  the  RHP  Debenture  at the
         Mandatory Default Amount.  The Mandatory Default Amount was 130% of the
         aggregate principal amount of the Debenture. On September 22, 2006, the
         Company  paid RHP the sum of $791,375  including  an  $182,625  Default
         Amount, thereby discharging the RHP debenture obligation.

         On September 26, 2006, Palisades Master Fund, LP ("Palisades") gave the
         Company its notice of election  accelerating  payment of the  Palisades
         Debenture at the  Mandatory  Default  Amount  asserting a cross default
         event  triggered  by the RHP Notice of Default  Event  received  by the
         Company on September 20, 2006, as disclosed in the Current Report filed
         on Form 8-K on September 25, 2006. Palisades demanded immediate payment
         of its Debentures at the Mandatory Default Amount of $5,597,687.

         On September  28,  2006,  Company  entered into a Waiver and  Amendment
         Agreement  ("Agreement")  with  Palisades  and  all  of  the  remaining
         Holders,  which include Crescent  International,  Ltd., Double U Master
         Fund, LP, JGB Capital, LP and Nite Capital, LP.


                                      -13-

<PAGE>

                         TIDELANDS OIL & GAS CORPORATION
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 2006


NOTE 6 - DEBT FINANCING (CONTINUED)
------   --------------------------

         In  consideration  of that  Agreement,  all existing  events of default
         known to the Holders  were waived in  consideration  of the issuance of
         2,828,304  common  shares.  The  Company  issued the shares as follows:
         Palisades - 2,000,000 shares,  Crescent  International,  Ltd. - 304,375
         shares,  Double U Master Fund, LP - 152,179 shares,  JGC Capital,  LP -
         250,000  shares,  and Nite Capital,  LP - 121,750  shares (See NOTE 3 -
         Common Stock Transactions).






















                                      -14-


<PAGE>

Item 2. Management's  Discussion and Analysis of Financial Condition and Results
        of Operation

Business Overview

Our products and services are primarily  focused on development and operation of
transportation,  processing,  distribution  and storage projects for natural gas
and  natural  gas  liquids  in the  northeastern  states of  Mexico  (Chihuahua,
Coahuila, Nuevo Leon and Tamaulipas) and the state of Texas in the United States
of America.  The Company has also begun a  feasibility  study for the  potential
development of an offshore LNG  regasification  terminal and connecting  natural
gas pipeline in the vicinity of Long Beach, California.

We derive our revenue from  transportation  fees from delivery of natural gas to
Conagas, the local distribution company in Piedras Negras, Coahuila, through the
pipeline owned by Reef Ventures,  L.P.  Additionally,  revenues are derived from
the provision of  construction  services for yard lines and meter sets installed
to a homeowner's  lot, and the sale of propane gas to  residential  customers in
Central Texas through the assets owned by Sonterra Energy Corporation.

Recent Developments

In the nine months ended September 30, 2006,  several  significant  developments
occurred with respect to the businesses operated by the Company.

Financing Transaction

On January 20, 2006, the Company  entered into  Securities  Purchase  Agreements
(the "Agreements) with seven accredited investors (collectively,  "Purchasers or
Holders").  The original  Holders  included  Palisades  Master Fund,  L.P.,  PEF
Advisors, Crescent International, Ltd., Double U Master Fund, L.P., JGB Capital,
L.P. and Nite Capital,  L.P., and RHP Master Fund, Ltd.  Palisades  subsequently
acquired PEF Advisors interests in the Agreements.

We sold $6,569,750  Dollars,  in the aggregate  principal  amount, of discounted
convertible  debentures  ("Debentures")  and Series A and  Series B Warrants  to
purchase common stock  ("Warrants") for an aggregate payment of $5,396,098 after
deduction  for the interest  discount.  The Company paid an 8% commission to the
placement agent, HPC Capital Management,  LLC, a registered  broker-dealer.  The
Company granted HPC Capital  Management  Series A Common Stock Purchase Warrants
as additional  transaction  compensation.  The Company  received net proceeds of
$4,949,292 after deduction of legal costs, commissions and interest discount. We
intend to use the proceeds for working capital.




                                      -15-
<PAGE>

The sale of these  securities  required the Company to increase  its  authorized
common stock capital because it had  insufficient  authorized  capital to comply
with all of the Debenture  conversion and Warrant exercise provisions  contained
in the Transaction  Documents.  We have reserved  9,000,000 common shares of our
unissued authorized common stock capital for the transaction. On April 17, 2006,
an amendment to the  articles of  incorporation  of the Company was approved via
written consent in lieu of a special meeting of the  shareholders of the Company
and on April 19,  2006,  the Company  amended its articles of  incorporation  by
increasing  its  authorized  common  stock  capital  from  One  Hundred  Million
(100,000,000)  shares,  par value $0.001 per share to Two Hundred  Fifty Million
(250,000,000)   shares,   par  value  $0.001  per  share,  thus  satisfying  the
requirements of the financing documents.

We agreed to file a registration statement. We filed a registration statement on
Form SB-2 and later converted to Form S-1 with the U.S.  Securities and Exchange
Commission  ("SEC") to register the common stock  underlying  the Debentures and
Warrants.

The  Debentures  are Original  Issue  Discount  Convertible  Debentures  with an
aggregate face amount of $6,569,750.  The purchasers paid an aggregate principal
sum of  $5,396,098.  The face amount of the  Debentures is due January 20, 2008.
The  difference  between  the  face  amount  and the  aggregate  principal  paid
represents the interest expense. The Debenture Holder may convert all or part of
the Debenture face amount into shares of Tidelands'  common stock at any time at
an initial conversion rate of $0.87 per share.

The Purchasers have agreed to restrict their ability to convert their Debentures
or Exercise their Warrants and receive our shares such that the number of shares
of common stock held by each of them  individually  in the aggregate  after such
conversion or exercise does not exceed 4.99% of the then issued and  outstanding
Company common shares. This beneficial ownership limitation may be waived by the
Holder.

Subject to specific terms and  conditions in the Debenture,  the Company has the
option to force conversion of the Debentures into common shares if the Company's
share price as quoted on the Over-the-Counter  Electronic Bulletin Board exceeds
250% of the  then  Conversion  Price  for a  period  of time  based  on a Volume
Weighted Average Price ("VWAP")  formula.  The VWAP share price must exceed this
250% price for at least 20 consecutive Trading Days.

The conversion price will be subject to adjustment for corporate events, such as
stock splits,  stock dividends,  and stock  combinations,  as more  specifically
outlined in the transaction documents.

We granted the  Purchasers  Series A Common Stock Purchase  Warrants  ("Series A
Warrants") to purchase 2,491,974 shares of our common stock at $0.935 per share.
We also granted HPC Capital  Management 65,697 Series A Warrants to purchase our
common stock at $0.935 per share.





                                      -16-
<PAGE>

The  Series A  Warrants  may be  exercised  immediately  by the  Purchasers  and
terminate on January 20, 2009.  Subject to specific  terms and conditions in the
Series A Warrant  including  an  effective  registration  statement  registering
underlying  shares,  the Company has the call option to force conversion of this
Warrant  into  common  shares  if the  Company's  share  price as  quoted on the
Over-the-Counter  Electronic  Bulletin  Board exceeds 250% of the then effective
Exercise  Price for a period of time  based on a VWAP  formula.  The VWAP  share
price must exceed this 250% threshold price for at least 20 consecutive  Trading
Days.  If at any time  after  one year  from  the date of  issuance  there is no
effective registration statement registering, or no current prospectus available
for the resale of the underlying shares, then this Warrant may also be exercised
by means of "cashless  exercise"  as  determined  by a formula  described in the
Warrant.  The exercise price will be subject to adjustment for corporate events,
such  as  stock  splits,  stock  dividends,  and  stock  combinations,  as  more
specifically outlined in the transaction documents.

We granted the  Purchasers  Series B Common Stock Purchase  Warrants  ("Series B
Warrants") to purchase 7,551,432 shares of our common stock at $1.275 per share.
The  Purchasers  have the right to exercise the Series B Warrants  commencing at
any time on, or after  January 20,  2007 and on, or before  February  19,  2007.
Subject to specific terms and  conditions in the Series B Warrant,  including an
effective  registration statement registering underlying shares, the Company has
the option to force the  exercise  of this  Warrant  into  common  shares if the
Company's  share  price as quoted on the  Over-the-Counter  Electronic  Bulletin
Board  exceeds 150% of the then  effective  Exercise  Price for a period of time
based on a VWAP  formula.  The VWAP share price must exceed this 150%  threshold
price for at least 20  consecutive  Trading  Days. If at any time after one year
from  the  date  of  issuance  there  is  no  effective  registration  statement
registering, or no current prospectus available for the resale of the underlying
shares,  then this Warrant may also be exercised by means of "cashless exercise"
as determined by a formula described in the Warrant.  The exercise price will be
subject  to  adjustment  for  corporate  events,  such as  stock  splits,  stock
dividends,  and  stock  combinations,  as  more  specifically  outlined  in  the
transaction  documents.  We granted the  Purchasers  and HPC Capital  Management
registration  rights on the shares  underlying  the Debentures and the Warrants.
The Common Stock underlying the Debentures and Warrants will be registered under
the  Securities  Act of 1933,  as  amended,  for  re-offer  and  re-sale  by the
Purchasers and HPC Capital Management.

If the Company failed to timely file a  registration  statement or was unable to
have the registration  statement declared effective by the SEC within the stated
periods of time,  this  would  trigger a default  and be subject to among  other
things,  acceleration of the Debentures, at the Purchasers' options,  additional
default interest payment and monetary liquidated damages. The liquidated damages
will be capped at 20% of the Debentures' face amounts.



                                      -17-
<PAGE>

The registration  provisions of the Agreements  required the Company to have the
registration  statement  declared  effective  by  the  Securities  and  Exchange
Commission  on, or before  June 20,  2006,  ("Effectiveness  Deadline"),  or pay
liquidated damages until the registration  statement was declared effective.  On
June 20,  2006,  the  Company was  obligated  to pay  liquidated  damages to the
Holders,  however, did not pay all of the holders timely.  Failure to timely pay
these liquidated  damage sums  constituted an event of default.  The Company has
paid all of the  Effectiveness  Deadline  liquidated damage sums to each Holder,
albeit untimely.  However,  prior to these payments,  on September 20, 2006, one
Holder,  RHP Master Fund,  Ltd.  ("RHP") gave the Company its notice of election
accelerating payment of the RHP Debenture at the Mandatory Default Amount. Under
the Debenture terms defining  default events,  a Holder may elect to declare the
aggregate principal  Debenture amount,  together with other amounts owing to the
date of  acceleration,  immediately  due and  payable  in cash at the  Mandatory
Default Amount.  In the RHP case, the elected  Mandatory Default Amount was 130%
of the aggregate  principal amount of the Debenture.  On September 22, 2006, the
Company  paid RHP the sum of  $791,375  thereby  discharging  the RHP  debenture
obligation.  On September 26, 2006,  Palisades  Master Fund, L.P.  ("Palisades")
gave the Company its notice of election  accelerating  payment of the  Palisades
Debenture  at the  Mandatory  Default  Amount  asserting a cross  default  event
triggered by the RHP Master Fund,  Ltd.  Notice of Default Event received by the
Company on September  20, 2006. On September  27, 2006,  Company  entered into a
Waiver and Amendment Agreement with Palisades and all of the remaining Debenture
Holders,  which included  Crescent  International,  Ltd.,  Double U Master Fund,
L.P., JGB Capital,  L.P. and Nite Capital,  L.P. We issued the Holders 2,828,304
shares in  consideration  for the Waiver and  Amendment  Agreement.  The Company
agreed to register these shares with the Securities and Exchange  Commission and
this registration statement has been prepared and filed for this purpose.

Esperanza Energy, LLC

Esperanza Energy, LLC, ("Esperanza") was formed as a wholly-owned  subsidiary of
the Company in March 2006 to evaluate the feasibility of developing an offshore,
deep-water  liquefied  natural gas (LNG) regas  terminal in the offshore  waters
near Long Beach,  California.  Esperanza would utilize TORP Technology's  HiLoad
LNG Regas unit which attaches to an LNG tanker, directly vaporizes the LNG as it
is offloaded and injects the  regasified  natural gas into an undersea  pipeline
for  transportation  of  the  natural  gas  to  onshore  metering  stations  and
transmission  pipelines to supply nearby gas markets.  The TORP HiLoad LNG Regas
unit  eliminates  the need for  extensive  above-ground  storage  tanks or large
marine structures required for berthing and processing of the LNG.

Esperanza  is  conducting  the  feasibility  study  for  this  project  with the
assistance of best-in-class LNG, environmental,  pipeline and legal experts that
include:  David Maul, former Manager of the California Energy Commission Natural
Gas Office,

     o    ENTRIX,   Inc.,  a  professional   environmental   consulting  company
          specializing  in  environmental  permitting  and  compliance for major
          offshore oil and gas projects in California and the United States,



                                      -18-
<PAGE>

     o    Project   Consulting   Services,   Inc.,  a  leader  in   engineering,
          construction,  management,  and  inspection  of onshore  and  offshore
          pipelines, and
     o    Pillsbury Winthrop Shaw Pittman,  LLP, an  interdisciplinary  law firm
          with  leading  practices in  environmental,  land use and energy legal
          advice and in project development and finance.

Active   consultations   continue  with  California   stakeholders,   commercial
counterparties,  financial investors, and the above mentioned team regarding the
optimal design and operational configuration of the project. A primary objective
of the project  feasibility  study is to design the project to exceed California
environmental, public health and safety requirements. An announcement concerning
the results of the  feasibility  study and  whether the Company  will pursue the
project is expected prior to the end of the first quarter of 2007.

Sonora Pipeline, LLC, and Terranova Energia, S. de R.L. de C.V.

The  cross-border gas pipeline and storage  development  activities of the above
entities to establish the Burgos Hub Export/Import project progressed forward in
two principal areas:

Permitting Activities -
Sonora Pipeline,  LLC, ("Sonora") continued its efforts to finish all activities
necessary to move from NEPA pre-filing  status to a submission for Certification
for its two International  Pipeline U.S.  segments,  the Progreso  International
Pipeline and the Mission  International  Pipeline.  Sonora believes it has filed
all  needed  revisions  to the  Draft  Environmental  Report  for both  pipeline
segments   with  FERC  for  purposes  of  the  NEPA   Environmental   Assessment
requirements. The Progreso International Pipeline is the eastern leg of the U.S.
pipelines which will interconnect  with the Tennessee Gas Pipeline  transmission
lines at the  Alamo  Station  and  deliver  natural  gas to the  Brasil  Storage
facility  approximately  17 miles south of the  U.S./Mexico  border at Progreso,
Texas. The Mission  International  Pipeline segment was re-designed in the first
quarter of 2006 due to a routing  conflict  with a fiber optic line.  It will be
approximately 24 miles long and will commence at the existing HPL Valero-Gilmore
gas plant in Hidalgo  County,  Texas,  and  extend  southward  to the  Arguelles
crossing of the Rio Grande River into Mexico near the city of Mission, Texas. We
anticipate the issuance of an  Environmental  Assessment by the staff of FERC in
the  first  quarter  of 2007 to be  followed  by a  complete  application  for a
Certificate of Public  Convenience and Necessity to construct,  own, operate and
maintain the proposed pipelines.  The current catalog of FERC correspondence for
Sonora's activities is located at www.ferc.gov under Docket No. PF05-15.

On May  23,  2006,  Terranova  Energia,  S. de R.L.  de  C.V.  ("Terranova"),  a
wholly-owned  subsidiary  of the  Company,  was awarded a permit by the Comision
Reguladora  de  Energia  de Mexico  ("CRE") to  construct  its 30 inch  diameter
natural gas  pipeline  segment in Mexico to link to the Sonora's  United  States
pipelines and Terranova's  proposed  underground natural gas storage facility in
the Brasil field (located  approximately 17 miles south of Nuevo Progreso on the
U.S./Mexico  border in  Texas).  Terranova  submitted  the  application  for the



                                      -19-
<PAGE>

storage  facility  permit to the CRE on August 5, 2005 and it was  accepted  for
full review on October 14, 2005.  Several unique  questions are presented by the
filing of this  permit due to the  proposed  location  and the lack of  previous
storage  permit  applications  having been  considered  by the CRE.  The CRE has
recently  selected GEOSTOCK (an entity owned 50% by Total, 25% by BP, and 25% by
Entrepose  Contracting)  as its  technical  consultant  to  review  the  storage
facility permit application. GEOSTOCK is an international engineering group with
over 40 years experience in the design,  construction and operation of all types
of underground storage facilities for liquid, liquefied or gaseous hydrocarbons.
The technical  review of the permit  application  is expected to be completed by
the end of 2006.  Management  expects the  storage  permit  application  will be
presented for decision by staff to the CRE Commissioners in the first quarter of
2007.

Commercial Activities -
The Company continues to present the pipeline and storage segments of the Burgos
Hub  Export/Import  project to commercial  audiences in efforts to solicit their
interest and  participation  in the project at various  levels.  There have been
numerous  introductory  meetings  with  staff  of  the  CFE  and  the  Monterrey
industrial consumers of natural gas with a view toward clarifying their need and
usage of the proposed project facilities.  Letters of Intent concerning capacity
reservation  of the project  facilities  are  currently  underway  with  various
industrial  customers  and  natural  gas  distributors  in the  Monterrey  area.
Discussions with an industrial group concerning the acquisition of rights of way
is ongoing due to potential cost savings for this important  project  component.
Preliminary  evaluation of demand for storage  capacity  reservation  based upon
direct discussion with the various  customers is conservatively  estimated at 40
Bcf for the  market  area  influenced  by the  project.  Similarly,  discussions
continue with interested  parties in the U.S. and Mexico regarding the execution
of a joint  development  agreement  between  Terranova  and their  firms for the
funding,  development and ownership of the project.  An announcement  concerning
the participation of these parties is expected in the fourth quarter of 2006.

Sonterra Energy Corporation

The residential home markets in Central Texas remain strong and are reflected in
the  continued  growth of new meter hookups in existing  subdivisions  served by
Sonterra  Energy  Corporation.  Sonterra  served  1,115  customers  with propane
service at the end of the third  quarter of 2006 with an additional 40 customers
added in  existing  subdivisions  during the  quarter.  Construction  activities
continue in the existing  subdivisions,  such as Senna Hills, where an expansion
phase of development  will result in the addition of  approximately 50 customers
in the near future.  Sonterra's  participation in the launch of new subdivisions
is also occurring, as exemplified by the signing of a construction contract with
the developers of Las Brisas at Ensenada Shores (located on Canyon Lake),  where
75 new lots with propane  service have been completed for sale to new customers.
This  subdivision's  second phase of  development is expected to add another 175
lots.  Construction continues on Section 205 of the Cordillera Ranch subdivision
which  will add 50 more  residential  customers  when  completed  in the  fourth
quarter of 2006.




                                      -20-
<PAGE>

Sonterra has expanded into  additional  markets as evidenced by the signing of a
construction  contract to build a central propane system for a multi-use  retail
center in Lago Vista,  Texas. The system will serve five to ten large commercial
customers including two restaurants.

FORWARD-LOOKING STATEMENTS:

We have included  forward-looking  statements in this report.  For this purpose,
any  statements  contained in this report that are not  statements of historical
fact may be  deemed  to be  forward-looking  statements.  Without  limiting  the
foregoing,  words  such as "may",  "will",  "expect",  "believe",  "anticipate",
"estimate",  "plan" or "continue" or the negative or other variations thereof or
comparable  terminology  are  intended to identify  forward-looking  statements.
These statements by their nature involve  substantial  risks and  uncertainties,
and actual  results  may differ  materially  depending  on a variety of factors.
Factors that might cause  forward-looking  statements to differ  materially from
actual  results  include,  among other  things,  overall  economic  and business
conditions,  demand  for the  Company's  products,  competitive  factors  in the
industries  in which we compete or intend to compete,  natural gas  availability
and cost and timing,  impact and other  uncertainties of our future  acquisition
plans.

Results of Operations

REVENUES:  The Company reported revenues of $1,578,244 for the nine months ended
September  30, 2006 as compared  with  revenues  from  continuing  operations of
$1,216,626 for the nine months ended  September 30, 2005.  The revenue  increase
resulted  primarily from increasing  revenues of Sonterra Energy Corporation due
to an increase in total  customers  served and product  prices in the first nine
months of 2006 versus the first nine months of 2005.

TOTAL COSTS AND EXPENSES:  Total costs and expenses from  continuing  operations
decreased  from  $12,987,237  for the nine months  ended  September  30, 2005 to
$9,121,500 for the nine months ended  September 30, 2006.  The principal  reason
for this amount of decrease was the lack of expense for  Impairment  Loss in the
nine months ended  September 30, 2006 versus the nine months ended September 30,
2005.

COST OF SALES:  Total Cost of Sales  increased from $635,113 for the nine months
ended  September  30, 2005 to $759,954 for the nine months ended  September  30,
2006. This increase  resulted from the increased cost and volume of propane sold
by Sonterra  Energy  Corporation  in the nine months  ended  September  30, 2006
versus September 30, 2005.

OPERATING EXPENSES: Operating expenses from continuing operations increased from
$210,545 for the nine months ended  September  30, 2005 to $286,128 for the nine
months ended  September 30, 2006.  This increase was primarily due to additional
operating expenses incurred by Sonterra Energy Corporation in its operations for



                                      -21-
<PAGE>

the period  which  were not  present in the  comparative  nine  months for 2005.
Depreciation  expense declined in the first nine months of 2006 versus the first
nine  months  of  2005,  decreasing  from  $360,817  for the nine  months  ended
September  30, 2005 to $345,887  for the nine months  ended  September  30, 2006
reflecting a minor decrease in depreciable assets for the respective periods due
to impairment charges.

INTEREST  EXPENSE:  Interest expense increased from $503,950 for the nine months
ended  September 30, 2005 to $3,057,258 for the nine months ended  September 30,
2006  primarily  as a result of three  factors:  (a)  interest  penalties in the
amount of  $1,696,182  in  connection  with the  payment of stock to the various
investors  upon  the  defaults  described  in  Notes  3 and 5 of  the  Financial
Statements,  (b)  liquidated  damage  payments in the amount of $478,155 paid in
cash to the  various  investors  upon as  described  in Note 5 of the  Financial
Statements,  and  (c)  interest  paid  in  connection  with  the  conversion  of
debentures  to common  stock in the amount of $277,282  during the period  ended
September  30,  2006.  No income or expense for  Beneficial  Conversion  Feature
Interest was recorded for the nine months ended  September  30, 2006 as compared
to ($501,659) for the nine months ended September 30, 2005. The market price for
the  Company's  common stock at the relevant  measurement  dates during the nine
months  ended  September  30,  2006 was less than the  conversion  price for the
debentures issued on January 20, 2006. Accordingly,  there was no benefit to the
holders of the debentures in the event of conversion during those periods and no
beneficial conversion interest charge was recorded.

SALES,  GENERAL AND  ADMINISTRATIVE:  Sales,  General & Administrative  Expenses
decreased by  $1,906,198  during the nine months ended  September  30, 2006 to a
total  amount of  $4,672,273  as compared  $6,578,471  for the nine months ended
September 30, 2005.  This decrease was due primarily to the absence of financing
costs paid to Impact  International  LLC during the period ended  September  30,
2006 as compared to financing costs of $1,272,500  paid to Impact  International
LLC during the period ended September 30, 2005. The remaining decrease in Sales,
General &  Administrative  expense  was due to a  reduction  in the  issuance of
common stock for consulting  services during the nine months ended September 30,
2006 versus the nine months ended September 30, 2005.

IMPAIRMENT LOSS: No expense for impairment loss was recorded for the nine months
ended  September  30, 2006  compared to  $5,200,000  of  impairment  of goodwill
recorded as a loss for the period ended September 30, 2005.

DERIVATIVE GAIN: Gain from embedded derivative instrument  liabilities decreased
from  ($5,168,000)  for the nine months ended September 30, 2005 to zero for the
nine months ended September 30, 2006. The warrants issued in connection with the
January  20,  2006  financing  had an  exercise  price that was greater the fair
market value of the Company's  common stock at the relevant  measurement  dates.
Accordingly,  no  derivative  gain or reduction in liability for the issuance of
the  warrants in this  financing  transaction  was  recorded for the nine months
ended September 30, 2006.




                                      -22-
<PAGE>

NET LOSS: Net loss of ($6,211,713)  for the nine months ended September 30, 2005
increased to  ($7,433,260)  for the nine months  ended  September  30, 2006,  an
increase  in the amount of loss of  $1,221,547.  The  principal  reason for this
amount of increase in net loss was the lack of  Derivative  Gains to offset Loss
from  Operations  for the nine months ended  September  30, 2006 versus the nine
months ended September 30, 2005.  Included in the net loss of  ($7,433,260)  for
the  nine  months  ended  September  30,  2006 is  $1,562,800  of  expenses  for
employment contract costs and legal fees paid by issuance of common stock.

LIQUIDITY  AND CAPITAL  RESOURCES:  With  regard to  liquidity  and  adequacy of
capital  resources,   management  believes  that  adequate  liquidity  and  cash
resources exist to sustain current corporate activities for the remainder of the
fiscal year.  However, in the event that a decision to proceed with the offshore
LNG regas  terminal  project in Southern  California is made during the upcoming
months,  additional  funding for the permit  process will be needed.  Management
will evaluate the required budget and funding alternatives for such an effort as
an integral part of the project  feasibility  study underway.  Furthermore,  the
Company  will  need to raise  additional  capital  to fund  ongoing  development
activities  for its  Mexican  subsidiary,  Terranova  Energia  and  also to fund
operating  overhead at the parent  company  level.  New issuance of common stock
sufficient  to retire  the  outstanding  debentures  and to  provide  additional
required capital is under active negotiation. In addition, management is seeking
commitments  to fund the  development  activities of the Mexican and  California
projects by private equity  sources.  No assurance can be made that such capital
can be  acquired  in a timely  fashion  or at all.  Furthermore,  if  capital is
available through these sources,  if may be at terms that are disadvantageous to
the Company and its  shareholders.  In light of these possible  outcomes and the
current cash  resources  available for the  sustenance of corporate  operations,
management is taking  immediate  action to reduce  overhead  costs and otherwise
obtain cash resources for the Company.  Actions  underway  include  reduction of
staff,  termination of leases for the resulting unused office space,  subletting
of the Suite License Agreement with the San Antonio Spurs, LLC, conveyance of an
interest  in Reef  Ventures,  LP for  cash,  collection  of stock  subscriptions
receivable from current and past officers,  collection of an account  receivable
from an officer,  accelerated  collection of past due accounts from customers of
Sonterra Energy and Reef Ventures, LP, and collection of the $283,854 balance of
the Note Receivable for the related party aircraft  charter  services  including
termination of those services to the Company.  Furthermore,  management  expects
that in the fourth  quarter of 2006, the Company will begin  receiving  proceeds
from the sale and  transportation  of natural gas by its  subsidiary,  Tidelands
Exploration  &  Production,  as a result  of its  participation  in the  working
interests in the gas wells and the gathering pipeline located in Bexar,  Medina,
and Atascosa counties.

Direct  capital  expenditures  during the nine months ended  September  30, 2006
totaled  $2,525,218.   The  capital  expenditures  were  composed  of  increased
pre-construction costs regarding potential  international pipeline crossings and
storage facilities in Mexico,  pre-construction  costs regarding an offshore LNG
terminal in Southern California,  and additional machinery,  equipment,  trucks,
autos and trailers for the operation of the Sonterra Energy Corporation  propane
systems.  Total  debt  increased  from  $5,722,322  at  December  31,  2005 to $
11,239,928 at September 30, 2006. The increase in total debt is due primarily to
the  issuance  of  $6,569,750  of   convertible   debentures  in  the  financing
transaction  of January 20, 2006.  Net loss for the nine months ended  September
30,  2006 was  ($7,433,260)  an increase in net loss of 19% from the net loss of
($6,211,713) for the nine months ended September 30, 2005. Basic and diluted net
loss per common share  remained the same in the nine months ended  September 30,
2006 at ($0.05).  The net loss per share  calculation  for the nine months ended
September  30,  2006  included  an  increase  in actual  and  equivalent  shares
outstanding.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Cash and Cash Equivalents

We have historically invested our cash and cash equivalents in short-term, fixed
rate, highly rated and highly liquid  instruments which are reinvested when they
mature throughout the year. Although our existing investments are not considered
at risk  with  respect  to  changes  in  interest  rates or  markets  for  these
instruments,  our rate of return on short-term  investments could be affected at
the time of reinvestment as a result of intervening  events. As of September 30,
2006, we had cash and cash equivalents aggregated $887,194.

The  Company  does  not  issue  or  invest  in  financial  instruments  or their
derivatives for trading or speculative  purposes.  The operations of the Company
are conducted  primarily in the United  States,  and are not subject to material
foreign  currency  exchange risk.  Although the Company has outstanding debt and
related  interest  expense,  market risk of interest rate exposure in the United
States is currently not material.




                                      -23-
<PAGE>

Debt

The  interest  rate on our Impact  International  debt  obligation  is generally
determined  based on the prime interest rate plus two percent and may be subject
to market fluctuation as the prime rate changes.

Item 4. Controls and Procedures

(a)  Evaluation of Disclosure Controls and Procedures.

As of the end of the  reporting  period,  September  30, 2006, we carried out an
evaluation,  under the supervision and with the participation of our management,
including  the  Company's   Chairman  and  Chief   Executive   Officer/Principal
Accounting  Officer,  of the  effectiveness  of the design and  operation of our
disclosure  controls and procedures pursuant to Rule 13a-15(e) of the Securities
Exchange  Act of 1934  (the  "Exchange  Act"),  which  disclosure  controls  and
procedures are designed to insure that information required to be disclosed by a
company  in the  reports  that it files  under  the  Exchange  Act is  recorded,
processed, summarized and reported within required time periods specified by the
SEC's rules and forms.  Based upon that  evaluation,  the Chairman and the Chief
Financial  Officer  concluded  that our  disclosure  controls and procedures are
effective in timely alerting them to required material  information  relating to
the Company to be included in the Company's period SEC filings.

(b)  Changes in Internal Control.

Subsequent  to the date of such  evaluation  as  described in  subparagraph  (a)
above,  there were no changes in our  internal  controls or other  factors  that
could significantly affect these controls,  including any corrective action with
regard to significant deficiencies and material weaknesses.

(c)  Limitations.

Our  management,   including  our  Principal  Executive  Officer  and  Principal
Financial  Officer,  does not expect  that our  disclosure  controls or internal
controls over  financial  reporting  will prevent all errors or all instances of
fraud.  However,  we believe that our  disclosure  controls and  procedures  are



                                      -24-
<PAGE>

designed to provide reasonable assurance of achieving this objective.  A control
system,  no matter how well designed and operated,  can provide only reasonable,
not  absolute,  assurance  that the  control  system's  objectives  will be met.
Further,  the design of a control  system  must  reflect the fact that there are
resource  constraints,  and the benefits of controls must be considered relative
to their costs.  Because of the inherent  limitations in all control systems, no
evaluation of controls can provide  absolute  assurance  that all control issues
and instances of fraud,  if any,  within our company have been  detected.  These
inherent limitations include the realities that judgments in decision-making can
be faulty,  and that  breakdowns  can occur  because of simple error or mistake.
Controls can also be  circumvented  by the individual  acts of some persons,  by
collusion of two or more people, or by management override of the controls.  The
design of any system of controls is based in part upon certain assumptions about
the likelihood of future events, and any design may not succeed in achieving its
stated goals under all  potential  future  conditions.  Over time,  controls may
become  inadequate  because of changes in  conditions  or  deterioration  in the
degree of  compliance  with  policies  or  procedures.  Because of the  inherent
limitation of a  cost-effective  control system,  misstatements  due to error or
fraud may occur and not be detected.

                           PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Matter No. 1:

On January 6,  2003,  we were  served as a third  party  defendant  in a lawsuit
titled  Northern  Natural Gas Company vs. Betty Lou Sheerin vs.  Tidelands Oil &
Gas Corporation,  ZG Gathering, Ltd. and Ken Lay, in the 150th Judicial District
Court,  Bexar  County,  Texas,  Cause  Number  2002-C1-16421.  The  lawsuit  was
initiated by Northern Natural Gas when it sued Betty Lou Sheerin for her failure
to make  payments on a note she  executed  payable to  Northern in the  original
principal amount of $1,950,000.  Northern's suit was filed on November 13, 2002.
Sheerin  answered  Northern's  lawsuit  on January  6,  2003.  Sheerin's  answer
generally  denied  Northern's  claims  and raised the  affirmative  defenses  of
fraudulent inducement by Northern,  estoppel,  waiver and the further claim that
the  note  does  not  comport  with  the  legal  requirements  of  a  negotiable
instrument. Sheerin seeks a judicial ruling that Northern be denied any recovery
on the note.  Sheerin's  answer  included a counterclaim  against  Northern,  ZG
Gathering, and Ken Lay generally alleging, among other things, that Northern, ZG
Gathering,  Ltd. and Ken Lay,  fraudulently  induced her  execution of the note.
Northern has filed a general denial of Sheerin's counterclaims. Sheerin's answer
included a third party cross claim against Tidelands. She alleges that Tidelands
entered  into an  agreement  to  purchase  the Zavala  Gathering  System from ZG
Gathering Ltd. and that, as a part of the agreement, Tidelands agreed to satisfy
all of the obligations due and owing to Northern,  thereby  relieving Sheerin of
all  obligations  she  had to  Northern  on the  $1,950,000  promissory  note in
question.  Tidelands and Sheerin agreed to delay the  Tideland's  answer date in
order to  allow  time for  mediation  of the  case.  Tidelands  participated  in
mediation on March 11, 2003.  The case was not settled at that time.  Tideland's
answered  the Sheerin suit on March 26, 2003.  Tideland's  answer  denies all of
Sheerin's allegations.




                                      -25-
<PAGE>

On May 24 and June 16, 2004 respectively,  Betty Lou Sheerin filed her first and
second amended original answer,  affirmative  defenses,  special  exceptions and
second  amended  original  counterclaim,  second  amended  original  third party
cross-actions and requests for disclosure.  In these amended pleadings, she sued
Michael Ward, Royis Ward, James B. Smith,  Carl Hessell and Ahmed Karim in their
individual  capacities.  Her claims  against  these  individuals  are for fraud,
breach of contract,  breach of the Uniform  Commercial  Code,  breach of duty of
good faith and fair  dealing  and  conversion.  Sheerin has now  non-suited  her
claims against Michael Ward, Royis Ward, and James B. Smith.

In  September  2002,  as a  pre-closing  deposit to the  purchase  of the Zavala
Gathering System pipelines,  the Company executed a $300,000  promissory note to
Betty L.  Sheerin,  a partner of ZG  Gathering,  Ltd. In  addition,  the Company
issued 1,000,000 shares of its common stock to various partners of ZG Gathering,
Ltd. On December 3, 2003,  Sheerin filed a separate lawsuit against Tidelands in
the 150th District Court of Bexar County,  Texas on this promissory note seeking
a  judgment  against  Tidelands  for the  principle  amount  of the  note,  plus
interest.  On December  29th,  2003,  Tidelands  answered  this lawsuit  denying
liability  on the note.  On April 1, 2004,  Tidelands  filed a plea in abatement
asking  the  court  to  dismiss  or  abate  Sheerin's  lawsuit  on the  $300,000
promissory  note as it was  related  to and its  outcome  was  dependent  on the
outcome of the Sheerin  third  party cross  action  against  Tidelands  in Cause
Number  2002-C1-16421.  The company believes that the promissory note and shares
of common  stock should be  cancelled  based upon the outcome of the  litigation
described above. Accordingly, our financial statements reflect this belief.

On  September  15,  2004 and again on October  15,  2004  respectively,  Sheerin
amended her  pleadings to include a third and fourth  amended  third party cross
action against  Tidelands  adding a claim for the $300,000  promissory  note. In
these amended  pleadings,  Sheerin also deleted her claims  against Carl Hessell
and Ahmed Karim.  After adding the claim on the $300,000  promissory note to the
third party  claims of Sheerin  against  Tidelands  in Cause No.  2002-C1-16421,
Sheerin dismissed Cause Number 2002-C1-16421.

Tidelands won a partial summary  judgment  against Sheerin as to all of her tort
claims pled against Tidelands,  save and except only her claim for conversion of
500,000 shares of Tidelands' stock.

Sheerin seeks damages  against  Tidelands for indemnity for any sums found to be
due from her to Northern  Natural  Gas  Company,  unspecified  amounts of actual
damages, statutory damages,  unspecified amounts of exemplary damages, attorneys
fees, costs of suit, and prejudgment and post judgment interest.

On August 5,  2005,  Northern  Natural  Gas  Company  filed its  Fourth  Amended
Original  Petition which,  for the first time, named Tidelands as a defendant to
Northern.  Northern  seeks to  impose  liability  on  Tidelands  for  $1,950.000




                                      -26-
<PAGE>

promissory  note signed by McDay Energy  Partners,  Ltd. (the  predecessor to ZG
Gathering,  Ltd.) and Sheerin and the $1,700,000 promissory note signed by McDay
only.  Northern contends that Tidelands is alternatively  liable to Northern for
payment of both such promissory notes totaling  $3,709,914 plus interest because
Northern is a third party beneficiary under a December 3, 2001 purchase and sale
agreement  between ZG and Tidelands  claiming that in such  agreement  Tidelands
agreed to assume and satisfy all  indebtedness due and owing Northern by Sheerin
and ZG. Northern also claims that it is entitled to foreclosure of a lien on the
gas gathering  system and pipeline that was the subject of the promissory  notes
in question.

Tidelands has won a summary  judgment  motion it filed against  Northern and the
court has now dismissed Northern's claims against Tidelands.

On November 28, 2005, ZG Gathering, Ltd. and ZG Pipeline Management ("ZG") filed
its answer to  Northern's  Fifth Amended  Petition,  its  counter-claim  against
Northern, and its answer and cross claim against Tidelands. ZG contends that the
promissory notes given by ZG and Sheerin to Northern were procured by Northern's
fraudulent  misrepresentations  and it claims  unspecified  amounts  of  damages
against  Northern.  ZG's cross action against Tidelands claims Tidelands entered
into an agreement to purchase the Zavala  Gathering  System from ZG and that, as
part of that  agreement,  Tidelands  agreed to satisfy the  $3,700,914  Northern
indebtedness of ZG, and to defend,  indemnify,  and hold ZG and Sheerin harmless
from such  indebtedness,  to pay off a Sheerin loan of $300,000,  and to issue 1
million  shares of  Tidelands  stock,  of which  500,000 was to be free  trading
shares.  ZG claims that Tidelands  breached this agreement by failing to satisfy
the Northern  indebtedness,  failing to defend and  indemnify it from such debt,
failing to pay off the $300,000  note,  failing to issue the free trading shares
in Tidelands,  and by placing a stop transfer order on the restricted stock that
was  issued  by  Tidelands.  ZG seeks  specific  performance  of the  agreement,
recovery of an unspecified amount of damages, and its attorney's fees.

Much of the discovery has been completed at this time.  Based on  investigation,
and discovery to date,  Tidelands appears to have a number of potential defenses
to the claims of Sheerin and Northern. Tideland's intends to aggressively defend
these  lawsuits.  The  complexity  of the  issues in this case and the  inherent
uncertainties in litigation of this kind prevent a more definitive evaluation of
the extent of Tidelands' liability exposure.

Matter No. 2:

On May 4, 2005,  HBH  Development  Company,  LLC initiated  legal action against
Sonterra Energy Corporation ("Sonterra") in the District Court of Travis County,
Texas, 98th Judicial District,  Cause No. GN 501626 HBH Development Co., LLC vs.
Sonterra  Energy Corp. This action involves the developer of the Austin's Colony
Subdivision  in  Travis  County,  Texas  and  the  propane  distribution  system
originally constructed by Southern Union Company.  Southern Union entered into a
letter agreement with HBH concerning the construction and operation of a propane
distribution  system in the  subdivision  to be owned and  operated  by Southern



                                      -27-
<PAGE>

Union.  Southern  Union  assigned the letter  agreement and its interests in the
propane  system to Oneok,  Inc.,  the parent  company of Oneok Propane  Company.
Sonterra  acquired  its  interest  in the  propane  system  from  Oneok  Propane
Distribution Company. HBH is claiming that Sonterra has failed or refused to pay
HBH rent and  easement  use fees  under the terms of the letter  agreement.  HBH
alleges that  Sonterra's  actions cause a failure of the  assignment  whereby it
acquired  rights in the propane  system or  alternatively,  if the assignment is
effective,  for  breach  of  contract.  HBH  seeks to have the  court  terminate
Sonterra's rights in the propane distribution system, award unspecified monetary
damages,  cancellation  of the contract and rights  associated  with the propane
distribution system, issue to HBH a writ of possession for the property, and for
attorneys  fees. HBH has amended its complaint  adding claims for mutual mistake
and reformation as to the letter  agreement and a developer's  bonus under terms
of the letter agreement.

Sonterra is defending the legal action.  It believes that under the terms of the
letter agreement between HBH Development Company and Southern Union Company that
the easement use fees  terminated  when Southern  Union conveyed its interest in
the propane distribution system to Oneok Propane Company.

Matter No. 3:

On May 4, 2005, Senna Hills, Ltd. initiated legal action against Sonterra Energy
Corporation  in the  District  Court of  Travis  County,  Texas,  53rd  Judicial
District Cause No. GN 501625 Senna Hills,  Ltd. vs.  Sonterra  Energy Corp. This
action  involves the developer of the Senna Hills  Subdivision in Travis County,
Texas and the propane  distribution  system  originally  constructed by Southern
Union Company.  Southern Union entered into a letter  agreement with Senna Hills
concerning the  construction and operation of a propane  distribution  system in
the  subdivision  to be owned and  operated by Southern  Union.  Southern  Union
assigned the letter  agreement and its interests in the propane system to Oneok,
Inc.,  the parent  company  of Oneok  Propane  Company.  Sonterra  acquired  its
interest in the propane system from Oneok Propane  Distribution  Company.  Senna
Hills is claiming  that  Sonterra  has failed or refused to pay Senna Hills rent
and  easement  use fees under the terms of the  letter  agreement.  Senna  Hills
alleges that  Sonterra's  actions cause a failure of the  assignment  whereby it
acquired  rights in the propane  system or  alternatively,  if the assignment is
effective, for breach of contract. Senna Hills seeks to have the court terminate
Sonterra's rights in the propane distribution system, award unspecified monetary
damages, and cancellation of the contract and rights associated with the propane
distribution system, issue to Senna Hills a writ of possession for the property,
and attorneys fees.

Senna Hills sold certain  undeveloped  sections of Senna Hills  Subdivision to a
new owner.  Sonterra  believes that it has the right to expand its  distribution
system into such  undeveloped  sections of the  subdivision.  Sonterra  plans to
expand the  distribution  system into these sections under an agreement with the
new owner. Senna Hills has stated that although it is not presently objecting to
Sonterra's  expansion of the system at this time, it is reserving its claim that
Sonterra  does not have the right to do so and that it  intends to ask the court



                                      -28-
<PAGE>

to cancel  Sonterra's  right to use and  possession of the propane  distribution
system, including the system in the new sections of the subdivision. Senna Hills
has amended its complaint adding claims for mutual mistake and reformation as to
the  letter  agreement  and a  developer's  bonus  under  terms  of  the  letter
agreement.

Sonterra is defending the legal action.  It believes that under the terms of the
letter  agreement  between  Senna  Hills and  Southern  Union  Company  that the
easement use fees  terminated  when Southern  Union conveyed its interest in the
propane distribution system to Oneok Propane Company.

Matter No. 4:

On April 7, 2005, Goodson Builders,  Ltd. named Sonterra Energy Corporation in a
legal action titled, Goodson Builders,  Ltd, Plaintiff vs. Jim Blackwell and BNC
Engineering,  LLC,  Defendants.  The legal  action is in the  District  Court of
Travis County,  Texas 345th Judicial  District.  This legal action arises from a
claim that an  underground  propane  storage tank and  underground  distribution
lines is situated on the  Plaintiff's  lot in the Hills of Lakeway  subdivision,
Travis  County,  Texas.  Plaintiff  alleges  that there is no recorded  easement
setting forth the rights and  obligations  of the parties for use of the propane
tank and lines. However,  there is reference to a "suburban propane easement" on
the plat  document.  Plaintiff  alleges  that the property is being used without
permission  and the use  constitutes  an on-going  trespass.  Plaintiff asks the
court to determine that his lot is not subject to a "suburban propane easement",
declare the propane  equipment the property of plaintiff,  enjoin  Sonterra from
use of  Plaintiff's  land,  and award  damages.  The Plaintiff  seeks damages of
$165,000 based on a market rental rate he claims to be $5,000 per month, $50,000
damages  for  depreciation  of the value of the lot,  an  unspecified  amount of
exemplary damages, and attorneys' fees. Sonterra is defending the claims.

Item 1A. Risk Factors

WE MAY NOT HAVE ENOUGH FUNDING TO COMPLETE OUR BUSINESS PLAN.

We will need  additional  financing to fully  implement  our business  plan.  We
cannot give any assurance that this  additional  financing  could be obtained of
attractive  terms or at all. In addition,  our ability to raise additional funds
through  a private  placement  may be  restricted  by SEC  rules  which  limit a
company's ability to sell securities similar to those being sold in a registered
offering  before the time that  offering is completed  or otherwise  terminated.
Lack of funding could force us to curtail substantially or cease our operations.

FUTURE CAPITAL NEEDS COULD RESULT IN DILUTION TO INVESTORS; ADDITIONAL FINANCING
COULD BE UNAVAILABLE OR HAVE UNFAVORABLE TERMS.




                                      -29-
<PAGE>

Our Company's future capital requirements will depend on many factors, including
cash flow from  operations,  progress in its gas  operations,  competing  market
developments,  and  the  Company's  ability  to  market  its  proposed  products
successfully. Although the Company currently has specific plans and arrangements
for  financing  its  working  capital  is  presently  insufficient  to fund  the
Company's  activities.  It will be necessary to raise  additional  funds through
equity or debt  financings.  Any equity  financings  or debt  refinancing  could
result in dilution to our Company's then-existing stockholders.  Sources of debt
financing may result in higher interest  expense.  Any financing,  if available,
may be on terms unfavorable to the Company.  If adequate funds are not obtained,
the Company may be required to reduce or curtail operations.

SUBSTANTIAL CAPITAL REQUIREMENTS

We may make substantial  capital  expenditures for the development,  acquisition
and  production  of natural gas  pipeline,  processing  systems  and, or storage
facilities.  If revenues or the Company's equity financing  decrease as a result
of lower  natural  gas  prices,  operating  difficulties,  the  Company may have
limited  ability  to expend the  capital  necessary  to  undertake  or  complete
proposed plans and opportunities. There can be no assurance that additional debt
or equity  financing or cash  generated by operations  will be available to meet
these requirements.

THERE  CAN BE NO  ASSURANCE  THAT WE  WILL BE  ABILITY  TO  CONTINUE  AS A GOING
CONCERN.

Our substantial historical operating losses, limited revenues,  negative working
capital  and our  capital  needs  raise  substantial  doubt about our ability to
continue as a going  concern.  We can provide no assurances  that cash generated
from  operations  together  with  cash  received  in the  future  from  external
financing  sources  will be  sufficient  to  enable  us to  continue  as a going
concern.  If sufficient  cash cannot be obtained we would have to  substantially
alter  our  operations,  or  we  may  be  forced  to  substantially  curtail  or
discontinue some or all operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

During this fiscal quarter, we issued the following common stock:

On September 25, 2006,  the Company  issued  Michael Ward,  Ahmed Karim and Carl
Hessel  150,000  restricted  common  shares each as director  compensation.  The
shares were valued at $0.58 per share.

On September 28, 2006,  Company  entered into a Waiver and  Amendment  Agreement
(the,  "Agreement")  with Palisades Master Fund, L.P.,  Crescent  International,
Ltd.,  Double U Master Fund,  L.P.,  JGB Capital,  L.P. and Nite  Capital,  L.P.
(collectively,  "Holders"). In consideration of that Agreement, the Holders were
issued  2,828,304  common  shares.  The  Company  issued the shares as  follows:
Palisades Master Fund, L.P.: 2,000,000;  Crescent International,  Ltd.: 304,375;
Double U  Master  Fund,  L.P.:152,179;  JGB  Capital,  L.P.:  250,000;  and Nite
Capital, L.P.: 121,750. These shares were valued at $0.60 per share.

These are restricted  securities and may not be resold absent registration under
the  Securities Act of 1933, as amended (the  "Securities  Act") or an exemption
from the  registration  provisions of the  Securities  Act. We relied on Section
4(2) of the Securities Act as securities transaction exemption.




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<PAGE>

Item 3. Defaults Upon Senior Securities

Defaults relating to RHP Master Fund, Ltd. and Palisades Master Fund, L.P. were
disclosed under Item 2.04 titled "Triggering Event that Accelerates or Increases
a Direct Financial Obligation or an Obligation under an Off Balance Sheet
Arrangement" on Current Reports filed on Form 8-K September 25 and September 29,
2006.

Item 4. Submission of Matters to a Vote of Security Holders

No matters  were  submitted  to a vote of  security  holders  during the quarter
covered by this report.

Item 5. Other Information

Regency Energy Transaction

Tidelands Exploration and Production,  Inc. (TEPI) has completed its acquisition
of a 50% interest (with Regency Energy,  Inc.) in a 24-mile natural gas pipeline
located  in Medina,  Atascosa  and Bexar  Counties,  Texas.  This  Participation
Agreement  and  Joint  Operating  Agreement  with  Regency  allows  TEPI to take
stranded gas to market on leases in which TEPI has retained an interest.

Item 6.  Exhibits

a) Exhibits

      Exhibit No.                Exhibit Name

         10.1*             Regency Energy Participation Agreement
         10.2*             Regency Energy Joint Operating Agreement
         31.1              Chief  Executive  Officer-Section  302  Certification
                           pursuant to Sarbanes-Oxley Act.
         31.2              Chief Financial  Officer-  Section 302  Certification
                           pursuant to Sarbanes-Oxley Act.
         32.0              Chief  Executive  and Financial  Officer-Section  906
                           Certification pursuant to Sarbanes-Oxley Act.

         * Filed as  Exhibits  10.1 and 10.2 to the 10-Q  filed  for the  period
         ending June 30, 2006 which was filed on August 21, 2006.







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<PAGE>


                                   SIGNATURES

In accordance with the  requirements of the Exchange Act, the registrant  caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.

                                                TIDELANDS OIL & GAS CORP.


Dated: November 13, 2006                         /s/ Michael Ward
                                                --------------------------------
                                                By: Michael Ward
                                                Title: President, CEO



Dated: November 13, 2006                         /s/ James B. Smith
                                                --------------------------------
                                                By: James B. Smith
                                                Title: CFO, Principal Accounting
                                                Officer
















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