Petrolifera Petroleum Limited reports 2006 year end results



    CALGARY, March 20 /CNW/ - Petrolifera Petroleum Limited (PDP - TSX) had a
wonderful year in 2006. In its first full year of operations as a public
company and its second full year as a company, achievements and
accomplishments were considerable.

    Highlights are as follows:

    
    -   Revenue increased 36 times to $106 million, compared to $3 million in
        2005

    -   Cash flow from operations before working capital changes(1) increased
        120 times to $52 million after deduction current income taxes of
        $24 million, compared to cash flow of only $400,000 in 2005, after a
        current tax provision of $330,000 last year

    -   Cash flow per share(1) increased 67 times to $1.34 per share in 2006
        compared to only $0.02 per share in 2005; there were 39 million
        (basic weighted average) shares outstanding in 2006, compared to
        21 million shares in 2005. Fully diluted, there were 50 million
        outstanding in 2006 compared to 32 million in 2005. At December 31,
        2006 there were 44 million common shares outstanding (53 million
        fully diluted)

    -   Earnings were $40 million ($1.02 per share, basic) compared to a loss
        in 2005 of $400 thousand ($0.02 per share, basic)

    -   Year end working capital was $43 million with $51 million of cash

    -   Petrolifera has no debt

    -   Eight successful new wells were drilled in 2006 with no dry holes

    -   Daily average sales in 2006 was 17 times that of 2005, reaching
        6,171 boe/d, including 5,973 bbl/d of crude oil, all derived from the
        company's drilling program

    -   Fourth quarter 2006 production averaged 10,900 boe/d, including
        10,716 bbl/d of crude oil

    -   Proved reserves increased 99 percent over 2005 levels

    The following table summarizes these highlights and provides other
information with comparisons to results in 2005.

    HIGHLIGHTS

    -------------------------------------------------------------------------
                                                    2006      2005  % Change
    -------------------------------------------------------------------------
    FINANCIAL ($000 except per share amounts)
    -------------------------------------------------------------------------
    Total revenue                               $105,583    $2,864     3,587
    -------------------------------------------------------------------------
    Cash flow from operations before working
     capital changes(1)                           52,366       434    11,966
    -------------------------------------------------------------------------
    Per share, basic(1)                             1.34      0.02     6,600
    -------------------------------------------------------------------------
    Per share, diluted(1)                           1.05      0.01    10,500
    -------------------------------------------------------------------------
    Net earnings (loss)                           39,894      (415)    9,713
    -------------------------------------------------------------------------
    Per share, basic                                1.02     (0.02)    5,200
    -------------------------------------------------------------------------
    Per share, diluted                              0.80     (0.02)    4,000
    -------------------------------------------------------------------------
    Capital expenditures                          36,400     6,662       446
    -------------------------------------------------------------------------
    Cash on hand                                  51,008    19,744       158
    -------------------------------------------------------------------------
    Working capital                               43,038    17,886       141
    -------------------------------------------------------------------------
    Indebtedness                                       -         -         -
    -------------------------------------------------------------------------
    Shareholders' equity                          80,656    27,060       198
    -------------------------------------------------------------------------
    Total assets                                 118,517    31,581       275
    -------------------------------------------------------------------------
    OPERATING
    -------------------------------------------------------------------------
    Daily production/sales volumes
    -------------------------------------------------------------------------
    Crude oil - bbl/d                              5,973       145     4,019
    -------------------------------------------------------------------------
    Natural gas - mcf/d                            1,192     1,287        (7)
    -------------------------------------------------------------------------
    Barrels of oil equivalent - boe/d(2)           6,171       360     1,614
    -------------------------------------------------------------------------
    Reserves (mboe)(3)
    -------------------------------------------------------------------------
    Proved                                        12,898     6,477        99
    -------------------------------------------------------------------------
    Probable                                      11,436    16,717       (32)
    -------------------------------------------------------------------------
    Proved plus probable(4)                       24,334    23,194         5
    -------------------------------------------------------------------------
    Prices
    -------------------------------------------------------------------------
    Oil - $/bbl                                    47.71     43.73         9
    -------------------------------------------------------------------------
    Natural gas - $/mcf                             1.36      0.93        46
    -------------------------------------------------------------------------
    Barrels of oil equivalent - $/boe              46.43     20.93       122
    -------------------------------------------------------------------------
    Common shares outstanding (000s)
    -------------------------------------------------------------------------
    Weighted average - Basic                      39,132    20,721        89
    -------------------------------------------------------------------------
    Weighted average - Diluted                    49,956    31,803        57
    -------------------------------------------------------------------------
    End of period - Issued                        43,613    34,404        27
    -------------------------------------------------------------------------
    End of period - Fully diluted                 52,704    51,118         3
    -------------------------------------------------------------------------

    1) Cash flow from operations before working capital changes and cash flow
        per share do not have standardized meanings prescribed by Canadian
        generally accepted accounting principles ("GAAP") and therefore may
        not be comparable to similar measures used by other companies. Cash
        flow from operations before working capital changes includes all cash
        flow from operating activities and is calculated before changes in
        non-cash working capital. The most comparable measure calculated in
        accordance with GAAP would be net earnings. Cash flow from operations
        before working capital changes is reconciled with net earnings on the
        Consolidated Statement of Cash Flows and in the accompanying
        Management's Discussion & Analysis. Management uses these non-GAAP
        measurements for its own performance measures and to provide its
        shareholders and investors with a measurement of the company's
        efficiency and its ability to fund a portion of its future growth
        expenditures.
    (2) All references to barrels of oil equivalent (boe) are calculated on
        the basis of 6 mcf: 1/bbl. Boes may be misleading, particularly if
        used in isolation. This conversion is based on an energy equivalency
        conversion method primarily applicable at the burner tip and does not
        represent a value equivalency at the wellhead.
    (3) The reserve estimates for 2006 and 2005 were prepared by an
        independent professional petroleum engineering firm in accordance
        with National Instrument 51-101 (NI 51-101). Under NI 51-101, proved
        reserve assignments are based on a 90 percent certainty that total
        quantities received will equal or exceed proved reserve estimates.
        Proved plus probable reserves are the most likely case and are based
        on a 50 percent certainty that they will equal or exceed estimates.
        Proved plus probable plus possible reserves have a 10 percent
        probability that they will equal or exceed estimates.
    (4) After production of 2.3 million boe in 2006.
    (5) No dividends have been declared by the company since its
        incorporation.
    


    Summary fourth quarter 2006 results are contained in the enclosed MD&A.
    Petrolifera is able to report considerable progress and accomplishments
were achieved during 2006. The company is now well established with
consequential reserves, production and sales in Argentina. In addition to a
very successful drilling program during the year, field facilities and an oil
pipeline were constructed at its Puesto Morales operation in the Neuquén
Basin, Argentina. This program is continuing and will be expanded during 2007
to include enhanced recovery through installation of a waterflood for pressure
maintenance purposes. Also, a high pressure natural gas pipeline will be
installed to enable additional volumes of natural gas to be delivered to
market during 2007.
    Rig availability limited Petrolifera to the drilling of eight wells
during 2006. All of these wells encountered hydrocarbons and were completed as
either oil wells (some multi-zone) or as natural gas wells. This brought to
fourteen the number of successive discoveries drilled by Petrolifera at Puesto
Morales. A fifteenth successful well was drilled in March 2007.
    As a consequence, production and sales grew rapidly and successively
throughout the year. Fourth quarter 2006 sales were 47 percent higher than
levels achieved in the prior quarter and at 10,900 boe/d were over five times
first quarter levels of only 2,062 boe/d. Peak sales of 13,400 bbl/d for crude
oil and 13,700 boe/d on an equivalent basis were achieved during December
2006. Subsequently, the company has reduced production levels primarily for
natural gas conservation purposes until facilities are available to handle
additional natural gas sales volumes. Most of the increase was as a result of
new oil wells being placed onstream. Included in the new oil wells were two
wells in particular, namely 1012 and 1013. These offset the original new 2005
discovery at 1002 encountered excellent reservoir while drilling and are to be
prolific flowing oil wells, with almost no measurable water, since being
placed onstream in the third quarter. Overall water production remained
extremely low throughout the year.
    While its facilities were being sized and then constructed, Petrolifera
was fortunate to be able to access third party treatment plants and
accordingly trucked its produced oil to these sites. While adding minor
additional operating costs in the $1.00 -$1.50 per barrel range, operating
costs remained low at only $4.49 per boe for the year. Furthermore, these
arrangements permitted the company to achieve higher sales volumes than would
otherwise have been achievable. As increased volumes of production are treated
on site and then delivered to markets through our own 25 kilometer, six inch
pipeline which connects to the regional carrier, reductions in operating costs
are contemplated. Petrolifera expects to continue being a low cost operator.
    Revenue for the year was healthy at $106 million. This was achieved
despite the impact of Argentina's export tax on the pricing of crude oil in
the domestic market, where Petrolifera's crude oil production is sold. During
2006, the average price received of $47.71 per barrel of crude oil was only
nine percent above the 2005 price of $43.73 per barrel. Natural gas prices
improved considerably to $1.36 per mcf, a 46 percent improvement. On an
equivalent basis, the selling price in 2006 was $46.43 per boe, more than
double that recorded in 2005. This improvement reflects the higher percentage
of crude oil in the company's production mix as well as the continuing
improvement in natural gas prices, even with price controls.
    As a result of improved pricing and effective control of operating costs,
Petrolifera's corporate field netback improved 165 percent to $35.81 per boe,
compared to only $13.41 in 2005. At 77 percent of selling price, field
netbacks are attractive, even with the impact of price controls. This
improvement was achieved despite a significant increase in royalties payable
due to higher prices and due to a 21 percent reduction in unit operating costs
during the year. Field netbacks are calculated by dividing related revenue and
costs by total production on an equivalent basis, resulting in an overall
field netback. Netbacks do not have a standardized meaning prescribed by GAAP
and therefore may not be comparable to similar measures used by other
companies. For details regarding the calculation of field netback, product
netbacks and a reconciliation of field netback to net income, see
"Management's Discussion and Analysis - Operating Expenses and Netbacks.
    General and administrative expenses were $3.7 million in 2007 ($1.66 per
boe of sales) reflecting an expansion of operations during the year.
    Cash flow from operations before working capital changes amounted to
$52 million ($1.34 per share) in 2006, compared to only $434 thousand
($0.02 per share) in 2005. This was achieved after provision for $24 million
of current taxes during the year. Petrolifera was self-sufficient during the
year as capital expenditures totaled $36 million, mostly in Argentina. In
addition to drilling and facilities construction in Argentina, Petrolifera
also shot a 263 square kilometer seismic program over most of the previously
unshot 95,000 acres which comprise the Puesto Morales/Rinconada Concession.
Argentinean capital spending totaled $34 million. The balance was spent in
Peru and in investigating new opportunities in Colombia. A variety of field
programs and considerable data reprocessing and interpretation was conducted
in Peru during 2006; a much more active program is envisaged for our two large
licenses in 2007.
    Earnings were a robust $40 million ($1.02 per share) compared to a modest
loss of only $400 thousand last year. This represented an approximate
50 percent return on year end 2006 shareholders' equity and a 75 percent
return on average recorded equity during 2006. Return on equity is a non-GAAP
measurement and with respect to return on year end equity has been calculated
herein by dividing net earnings by year end shareholders' equity as shown on
the company's balance sheet and then converting it to a percentage. The
calculation of return on average equity is done in the same manner except
shareholders' equity is the average of year end 2005 and year end 2006
amounts. Return on equity is used as a measurement of operating and financial
efficiency in capital markets.
    During the year, nine million common shares were issued upon the exercise
of outstanding warrants and options issued pursuant to the company's Stock
Option Plan. Proceeds were $8.4 million and when combined with the surplus of
funds from operations in excess of capital expenditures, resulted in year end
working capital for Petrolifera of $43 million, including $51 million of cash.
The company has no debt.
    As previously reported, Petrolifera's proved reserves ("1P") of crude oil
and natural gas increased 99 percent during 2006 to reach 13 million boe at
December 31, 2006. Proved and probable reserves ("2P") improved modestly to
24.3 million boe after production of approximately 2.3 million boe during the
year. Reserve volumes were estimated by GLJ Petroleum Consultants Ltd.
("GLJ"), independent engineering consultants of Calgary, Alberta.
    Since it embarked on its modern exploration program in late 2005,
Petrolifera has added 14.7 million boes of proved ("1P") reserves and
25.7 million boe of new proved and probable ("2P") reserves from corporate
capital budgets for those two years as reported in the company's financial
statements of $43 million. After provision for future capital requirements and
abandonment liabilities as forecast by GLJ in their year end 2006 reserve
report ("GLJ Report") totaling $47 million and treating Petrolifera's Puesto
Morales program as a project for 2005 and 2006, Petrolifera's finding,
development and onstream ("FD&A") costs are calculated to be $6.11 per boe for
1P reserve additions and $3.50 per boe for 2P reserve additions.
    Alternatively, using NI 51-101 parameters and guidelines for calculation
of the company's finding and development costs, for 2005 the company's finding
and development costs were $3.69 per boe for 1P reserve additions and $1.74
for 2P reserve additions. For 2006, the company's finding and development
costs were calculated to be $7.23 per boe for 1P reserve additions and $14.76
for 2P reserve additions. The average two-year finding and development costs
based on NI 51-101 parameters is accordingly calculated to be $5.46 per boe
for 1P reserve additions and $8.25 for 2P reserve additions.
    The aggregate of the exploration and development costs incurred in the
most recent financial year and the change during that year in estimated future
developments costs generally will not reflect total finding and development
costs related to reserves additions for that year.
    The company's recycle ratio is calculated by dividing corporate netbacks
per boe by finding and development costs per boe. While not a GAAP
measurement, it provides an indication of a company's reinvestment capability
and its ability to replace production. The higher the recycle ratio, the more
likely a company is judged to be able to replace production through
exploration and development and to grow its reserves. Petrolifera's recycle
ratio using 1P finding and development costs for 2006 is calculated to be five
(5) times. Using the two year average finding and development cost calculated
in accordance with NI 51-101 yields a recycle ratio based on 2006 netbacks of
6.6 times for 1P reserves and 4.3 times for 2P reserves. Using the project
approach results in a recycle ratio for 2P reserves of ten (10) times.

    Outlook

    Since year end, Petrolifera has reactivated its drilling program in
Argentina. The company expects to operate with three rigs under long-term
renewable contracts during 2007, with two additional rigs anticipated to be
available for use by Petrolifera before mid-year 2007. In addition to drilling
numerous development, stepout and exploratory wells for additional crude oil
and associated natural gas reserves and productivity on the Puesto Morales
Block, the company also anticipates it will develop additional non-associated
Loma Montosa natural gas reserves for tie-in during the year. Also, drilling
will be initiated on several new prospects developed from our 2006 3D seismic
program over the Rinconada Block, which is prospective for shallow Sierras
Blancas oil. Petrolifera anticipates it could drill up to 50 wells in 2007,
contingent upon timely availability of the two new rigs to be provided to it
during the next several months by the company's drilling contractor and the
results of its capital program.
    Recently, Petrolifera was able to successfully complete a satisfactory
resolution of the contractual matters related to the 1.1 million acre Salinas
Grande I concession situated northeast of its main holdings at Puesto Morales.
The company will secure an initial 50 percent working interest in the
concession on ground floor terms and will proceed with an exploration program
on the block during 2007. Petrolifera also has been advised it will be awarded
the Gobernador Ayala II block in La Pampa Province, Argentina. This block is
contiguous with the Salinas Grande I acreage and is immediately east of and on
trend with new oil discoveries made by another Canadian company active in the
region. Petrolfiera will be the operator of and own 100 percent of this block.
    Petrolifera is also bidding on and attempting to otherwise expand its
acreage and opportunity inventory in its key areas of interest in Rio Negro
and La Pampa provinces in Argentina.
    In Peru, Petrolifera will accelerate its activities in 2007 with plans to
conduct new 2D seismic programs on both Blocks 106 and 107 in the Maranon and
Ucayali Basins. These will follow completion of a densely-gridded high
resolution areomag/gravity program over Block 107. Detailed Environmental
Impact Assessments ("EIA") will be completed and submitted for approval for
both blocks and it is anticipated that commencing in the near term 600-800
kilometers of new 2D seismic will be shot on each license. Plans are being
formulated for drilling in 2008.
    In Colombia, Petrolfiera has been advised by Agencia Nacional de
Hidrocarburos ("ANH") that is will be awarded the Sierra Nevada License and a
Technical Evaluation Agreement ("AREA "C" TEA") over approximately 1.1 million
acres in the Lower Magdalena Basin. These lands offset two large natural gas
fields and are prospective for both crude oil and natural gas. Separate work
programs, including a 13,000 foot well commitment within 18 months for the
license, are envisaged for the two concession agreements.
    Also, Petrolifera has been advised by ANH that it will be awarded the
Turpial TEA over approximately 113,000 acres of prospective lands in the
Middle Magdalena Basin. These lands were formerly fee simple acreage owned by
a major oil company and are prospective for crude oil and offset the
established Velasquez and Cocorna oil fields. Petrolfiera may apply for a
license over this block in the future, and retains a first right to match any
other license proposal for the region during the 18 month primary term of the
TEA.
    This successful entry into Colombia gives Petrolfiera a desirable
diversity within its portfolio of properties and prospects, ranging from lower
risk opportunities in Argentina to higher risk but higher reward projects in
Peru, with Colombia judged to be in the middle of this spectrum. Petrolifera
believes the concession terms in all three countries are comparable and
attractive and intends to focus on these regions for the foreseeable future.
    In 2007 Petrolifera's capital budget, including anticipated expenditures
on new awards, has now been set at approximately $153 million. The company's
guidance suggests this can be financed from cash flow and working capital
without any equity financing. To ensure its financial strength and
flexibility, the company is in the process of finalizing a US$100 million
reserve-backed revolving credit facility with a large international bank.
Initial draws of up to US $60 million are being discussed.
    Petrolifera's full year guidance as advanced to shareholders in October
2006 will be reevaluated after the conclusion of an assessment of first
quarter 2007 results. Changes will be made and communicated to public markets,
if required, once the exact timing of the arrival of the two additional rigs
is crystallized. Currently, we anticipate full year cash flow will range
between $140-$150 million (approximately $3.00 per share), with full year oil
production targeted to average approximately 16,000 bbl/d and full-year
equivalent production (boe) targeted to average 18,000 boe/d. Year end 2007
working capital is anticipated to be approximately $50 million due to the
impact of anticipated additional cash in the treasury from the exercise of
outstanding $3.00 share purchase warrants (PDP.WT-TSX) which expire on May 8,
2007. Petrolifera expects to again be profitable in 2007 and in the absence of
acquisitions or the identification of other opportunities, anticipates
remaining debt-free with a US$60 million credit facility in place.
    Petrolifera's annual meeting of shareholders will be held at the Calgary
Petroleum Club in Calgary, Alberta at 3:00 PM local time on May 8, 2007.

    Petrolifera Petroleum Limited is a public Canadian crude oil and natural
gas exploration and production company engaged in drilling production and
sales activity in Argentina, Colombia and Peru in South America. The company's
current reserve, production and sales derive from its Puesto Morales/Rinconada
Concession in the Neuquén Basin, Argentina. Two large licenses comprising
5.2 million acres onshore Peru are also held. The company recently entered
Colombia and holds one license and two technical evaluation agreements in the
Lower and Middle Magdalena Basin. Active drilling, facility construction and
exploration programs are planned in all three jurisdictions during 2007 with
an internally-financed capital budget exceeding $150 million.

    FORWARD LOOKING STATEMENTS

    This press release contains forward-looking statements, including but not
limited to estimated reserves and future net revenues, future exploration and
development plans, anticipated capital expenditures and sources of funding in
respect thereof, forecast cash flow, production and year end working capital
and the expected awarding of certain technical evaluation assessments in
Colombia and certain exploration blocks in Argentina. These statements are
based on current expectations that involve a number of risks and
uncertainties, which could cause actual results to differ materially from
those anticipated. These risks include, but are not limited to risks
associated with the oil and gas industry (e.g. operational risks in
development, exploration and production delays or changes in plans with
respect to exploration or development projects or capital expenditures; the
uncertainty of reserve estimates; the uncertainty of estimates and projections
in relation to production, costs and expenses and health, safety and
environmental risks), the risk of commodity price and foreign exchange rate
fluctuations, the uncertainty associated with negotiating with foreign
governments and risk associated with international activity. Additional risks
and uncertainties are described in the company's Annual Information Form which
is filed on SEDAR at www.sedar.com.
    The reserves and future net revenue in this press release represent
estimates only. The reserves and future net revenue from the company's
properties have been independently evaluated by GLJ with effective date of
December 31, 2006. This evaluation includes a number of assumptions relating
to factors such as initial production rates, production decline rates,
ultimate recovery of reserves, timing and amount of capital expenditures,
marketability of production, future prices of crude oil and natural gas,
operating costs, abandonment and salvage values, royalties and other
government levies that may be imposed during the producing life of the
reserves. These assumptions were based on price forecasts in use at December
31, 2006 and many of these assumptions are subject to change and are beyond
the control of the company. Actual production, sales and cash flows derived
therefrom will vary from the evaluation and such variations could be material.
The present value of estimated future net cash flows referred to herein should
not be construed as the current market value of estimated crude oil and
natural gas reserves attributable to the company's properties.
    Forecast capital expenditures are based on Petrolifera's current budgets
and development plans which are subject to change based on commodity prices,
market conditions, drilling success and potential timing delays. Additionally,
forecast capital expenditures do not include capital required to pursue future
acquisitions. Anticipated production has been estimated based on the proposed
drilling program with a success rate based upon historical drilling success
and an evaluation of the particular wells to be drilled and has been risked.
Forecast cash flow has been estimated based on anticipated revenue (which is
dependent upon forecast production, commodity prices and exchange rates),
anticipated royalty rates (which is based upon the continuation of existing
legislation and contractual obligations) and forecast operating costs and
general and administrative expenses (which are based on assumptions including,
without limitation, the costs of services and equipment and foreign exchange
rates).
    Due to the risks, uncertainties and assumptions inherent in
forward-looking statements, prospective investors in the company's securities
should not place undue reliance on these forward-looking statements. Forward
looking statements contained in this press release are made as of the date
hereof and are subject to change. The company assumes no obligation to revise
or update forward looking statements to reflect new circumstances, except as
required by law.
    A barrel of oil equivalent (boe), derived by converting gas to oil in the
ratio of six thousand cubic feet of gas to oil, may be misleading,
particularly if used in isolation. A boe conversion is based on an energy
equivalency conversion method primarily applicable at the burner tip and does
not represent a value equivalency at the wellhead.

    MANAGEMENT'S DISCUSSION AND ANALYSIS

    The consolidated financial statements have been prepared in accordance
with Canadian generally accepted accounting principles ("GAAP") and are
presented in Canadian dollars. This MD&A provides management's view of the
financial condition of the company and the results of its operations for the
reporting periods. Information in this report contains forward-looking
information based on current expectations, estimates and projections of future
production, capital expenditures and available sources of financing. It should
be noted forward-looking information involves a number of risks and
uncertainties and actual results may vary materially from those anticipated by
the company. These risks and uncertainties include, but are not limited to,
political and economic conditions in the countries in which the company
operates, changes in market conditions, law or governing policy, operating
conditions and costs, operating performance, demand for crude oil and natural
gas, foreign currency exchange rate fluctuations, currency controls,
commercial negotiations and technical and economic factors. Throughout the
MD&A, per barrel of oil equivalent ("boe") amounts have been calculated using
a conversion rate of six thousand cubic feet of natural gas to one barrel of
crude oil (6:1). The conversion is based on an energy equivalency conversion
method primarily applicable to the burner tip and does not represent a value
equivalency at the wellhead. Boes and may be misleading, particularly if used
in isolation.

    
    SELECTED FINANCIAL INFORMATION

    -------------------------------------------------------------------------
    As at and for the Year Ended December 31        2006      2005      2004
    -------------------------------------------------------------------------
    ($000, except per share amounts)
    -------------------------------------------------------------------------
    Total revenue                               $105,583    $2,864      $123
    -------------------------------------------------------------------------
    Net earnings (loss)                           39,894      (415)      (26)
    -------------------------------------------------------------------------
      Per share, basic                              1.02     (0.02)        -
    -------------------------------------------------------------------------
      Per share, diluted                            0.80     (0.02)        -
    -------------------------------------------------------------------------
    Total assets                                 118,517    31,581     3,884
    -------------------------------------------------------------------------
    Long-term obligations for asset retirement     2,347       467     3,172
    -------------------------------------------------------------------------
    


    Since incorporation, Petrolifera's management has concentrated on
building a financially strong company.
    To this end, the company completed three equity financings, two by way of
private placement and one by way of initial public offering pursuant to a
prospectus dated October 17, 2005. The company's common shares and the
warrants offered in conjunction with the initial public offering were listed
for trading on the Toronto Stock Exchange on November 8, 2005 under the
symbols PDP and PDP.WT, respectively.
    During 2006 Petrolifera completed a $36.4 million capital program which
included drilling eight oil wells and the construction of an oil pipeline and
related facilities.
    The company's recent drilling program in Argentina was very successful
and including 2005 and 2006 drilling, resulted in 14 oil wells. Petrolifera
now owns 29 oil wells, of which 23 are currently producing. As arrangements to
treat produced crude oil were completed with third parties, production growth
was considerable in 2006. In late 2006 a 25 kilometer six-inch pipeline to
connect to market was placed in operation, thereby reducing the amount of the
light gravity crude oil to be trucked and treated by third party operators
prior to sale.
    Petrolifera's financial condition was strengthened considerably during
2006 and its asset base and financial results were strong.

    
    FINANCIAL AND OPERATING REVIEW
    PRODUCTION, PRICING AND REVENUE

    -------------------------------------------------------------------------
    Year Ended December 31                                    2006      2005
    -------------------------------------------------------------------------
    Daily sales volumes
    -------------------------------------------------------------------------
      Oil - bbl/d                                           $5,973      $145
    -------------------------------------------------------------------------
      Natural gas - mcf/d                                    1,192     1,287
    -------------------------------------------------------------------------
      Total - boe/d                                          6,171       360
    -------------------------------------------------------------------------
    Product pricing ($)
    -------------------------------------------------------------------------
      Oil - per bbl                                          47.71     43.73
    -------------------------------------------------------------------------
      Natural gas - per mcf                                   1.36      0.93
    -------------------------------------------------------------------------
      Revenue per boe                                        46.43     20.93
    -------------------------------------------------------------------------
    Petroleum and natural gas sales ($000)                 104,595     2,750
    -------------------------------------------------------------------------
    Interest and other income ($000)                           988       114
    -------------------------------------------------------------------------
    Total ($000)                                          $105,583    $2,864
    -------------------------------------------------------------------------
    


    Petroleum and natural gas revenues for 2006 were $104.6 million (2005 -
$2.8 million) on sales of 5,973 bbl/d (2005 - 145 bbl/day) of crude oil and
1,192 mcf/d (2005 - 1,287 mcf/d) of natural gas. The substantial increases in
revenue resulted from higher oil production volumes arising from the
successful 2006 and 2005 drilling program, which resulted in ten new producing
wells coming onstream in Argentina during the year. Also, higher prices for
oil and natural gas were realized. All production was from the company's
Argentinean properties.
    Crude oil production increased substantially during 2006. New discoveries
resulted in production rising to 5,973 bbl/d. This has significantly altered
the company's product mix. In 2006 sales of crude oil represented 97 percent
of the company's sales volumes; in 2005 natural gas sales represented
60 percent of the sales volumes. Crude oil prices increased nine percent to
average $47.71 per barrel throughout the year. Natural gas prices increased
46 percent to average $1.36 per mcf in 2006, reflecting some relaxation of
regulated Argentinean natural gas prices, which are still substantially below
prices prevailing in North American markets. Argentinean crude oil selling
prices reflect world prices for the respective quality of oil, adjusted for
the impact of Argentinean export taxes on domestic sales prices. All of
Petrolifera's production is sold in domestic markets. Natural gas prices have
been improving and are expected to continue improving in the future due to
market conditions and new policy initiatives aimed at market deregulation.
    Interest and other income of $988,000 in 2006 and $114,000 for 2005
related to interest earned on short-term cash deposits.

    ROYALTIES

    Royalties represent charges against production or revenue by governments
and landowners. Included in royalties are revenue taxes levied by provincial
jurisdictions. Royalties in 2006 were $14.8 million ($6.57 per boe), or
14.1 percent of oil and gas revenue.
    In the 2005 reporting period, royalties were $353,000 ($2.68 per boe) or
13 percent of oil and gas revenues.

    
    OPERATING EXPENSES AND NETBACKS
    Company Netbacks(1)

    -------------------------------------------------------------------------
    Year ended December 31                    2006                2005
    -------------------------------------------------------------------------
                                         Total   Per boe     Total   Per boe
    -------------------------------------------------------------------------
    ($000, except per unit amounts)
    -------------------------------------------------------------------------
    Average daily sales (boe/d)              6,171                 360
    -------------------------------------------------------------------------
    Petroleum and natural gas sales   $104,595    $46.43    $2,750    $20.93
    -------------------------------------------------------------------------
    Interest and other income              988      0.44       114      0.86
    -------------------------------------------------------------------------
    Royalties                          (14,796)    (6.57)     (353)    (2.68)
    -------------------------------------------------------------------------
    Net revenue                         90,787     40.30     2,511     19.11
    -------------------------------------------------------------------------
    Operating costs                    (10,111)    (4.49)     (749)    (5.70)
    -------------------------------------------------------------------------
    Corporate netback                  $80,676    $35.81    $1,762    $13.41
    -------------------------------------------------------------------------

    (1) Calculated by dividing related revenue and costs by total boe sold,
        resulting in an overall company netback. Netbacks do not have a
        standardized meaning prescribed by GAAP and therefore may not be
        comparable to similar measures used by other companies. Nevertheless,
        Petrolifera's management uses netbacks as a performance measurement
        of operating efficiency and the prevailing royalty regime. A high
        ratio of netback to selling price is a positive indicator.
    


    Petrolifera's netbacks improved 167 percent over those recorded in the
2005 reporting period. This primarily reflects increased sales of crude oil, a
46 percent increase in the boe selling price, higher interest income from cash
balances and lower operating costs, offset by higher royalties due to the
improved product prices for both crude oil and natural gas. Petrolifera's
calculated netback at $35.81 per boe is a healthy 77 percent of selling price.

    Operating Netbacks by Product for the years ended December 31, 2005 and
    2006

    Per unit netbacks are calculated by dividing netbacks by sales volumes.

    Operating netbacks by product type are indicated below.

    
    -------------------------------------------------------------------------
                                            Crude oil          Natural gas
    -------------------------------------------------------------------------
    2006                                 Total   Per bbl     Total   Per mcf
    -------------------------------------------------------------------------
    ($000, except per unit figures)
    -------------------------------------------------------------------------
    Average daily production               5,973 bbl/d         1,192 mcf/d
    -------------------------------------------------------------------------
    Petroleum and natural gas sales   $104,005    $47.71      $590     $1.36
    -------------------------------------------------------------------------
    Royalties                          (14,737)    (6.67)      (59)    (0.14)
    -------------------------------------------------------------------------
    Operating costs                    (10,052)    (4.61)      (59)    (0.14)
    -------------------------------------------------------------------------
    Field operating netback            $79,216    $36.43      $472     $1.08
    -------------------------------------------------------------------------

    -------------------------------------------------------------------------
                                            Crude oil          Natural gas
    -------------------------------------------------------------------------
    2005                                 Total   Per bbl     Total   Per mcf
    -------------------------------------------------------------------------
    ($000, except per unit figures)
    -------------------------------------------------------------------------
    Average daily production                 145 bbl/d         1,287 mcf/d
    -------------------------------------------------------------------------
    Petroleum and natural gas sales     $2,315    $43.73      $435     $0.93
    -------------------------------------------------------------------------
    Royalties                             (297)    (5.61)      (56)    (0.12)
    -------------------------------------------------------------------------
    Operating costs                       (630)   (11.91)     (119)    (0.25)
    -------------------------------------------------------------------------
    Field operating netback             $1,388    $26.21      $260     $0.56
    -------------------------------------------------------------------------
    


    On a per unit basis, royalties were higher in 2006 due to higher product
selling prices.
    Operating costs in 2006 declined on a per unit basis from 2005 reflecting
the impact of higher sales volumes, and strong new well productivity, offset
by trucking and third party treatment charges. Petrolifera anticipates these
offsets will be reduced once our new facilities on-site are fully functional.
Crude oil production in 2005 was from mature wells for most of the year and
operating costs reflected this until the fourth quarter when new flowing oil
wells were placed onstream.

    GENERAL AND ADMINISTRATIVE EXPENSES

    General and administrative ("G&A") expenses were $3.7 million in 2006,
reflecting costs incurred in Canada, Argentina and Peru. These costs primarily
consist of management and advisory fees, insurance, the cost of independent
reserve reports, travel and other administrative expenses. The increase from
2005 is attributable to increased staffing and much expanded activity levels.
G&A of $716,000 was capitalized in 2006 (2005 - $164,000) and non-cash
stock-based compensation costs of $3.6 million were recorded in the year (2005
- $124,000), reflecting a substantial increase in the company's share price
and its consequent effect on the determination of the fair value of all stock
options granted and vested in the year.

    FOREIGN EXCHANGE

    The impact of fluctuations in the Argentinean peso and the US dollar
relative to the Canadian dollar arising from settling foreign-denominated
transactions and from translating foreign denominated financial statements and
operating results of its integrated foreign operations resulted in a foreign
exchange loss of $439,000 in 2006 (2005 - $131,000 gain). The company's main
exposure to foreign currency risk relates to the pricing of crude oil sales,
costs and capital expenditures which are denominated in US dollars and
Argentinean pesos.

    DEPLETION, DEPRECIATION AND ACCRETION ("DD&A")

    DD&A is calculated using the unit-of-production method based on total
estimated proved reserves. DD&A in 2006 was $9.6 million (2005 - $826,000) or
$4.27 per boe (2005 - $6.29 per boe). This includes a charge of $27,000 (2005
- $25,000) to accrete the company's estimated asset retirement obligation.
These charges will continue to be necessary in future to accrete the currently
booked discounted liability of $2.3 million to the estimated total
undiscounted liability of $6.3 million over the estimated remaining economic
life of the company's oil and gas properties. Capital costs of $6.4 million
related to unevaluated properties in  Argentina and for major development
projects, and other assets in the pre-production stage principally related to
Peruvian assets, have been excluded from depletable costs. No proved reserves
have yet been assigned to this project. Additionally, future development costs
of $41.2 million for proved undeveloped reserves were included in the
depletion calculation.

    CEILING TEST

    Oil and gas companies are required to compare the recoverable value of
their oil and gas assets to their recorded carrying value at the end of each
reporting period. Excess carrying values over fair value are to be written off
against earnings. No write-down was required in 2006 or in 2005.

    TAXES

    The current income tax provision of $23.8 million for 2006 (2005 -
$330,000), primarily relates to income taxes in Argentina. Additionally, a
future tax recovery of $1.2 million for the year was recorded to recognize the
benefit of changes in tax pool balances. Taxes other than income taxes of
$655,000 represent taxes charged at a rate of 0.6% on all banking transactions
in Argentina.

    
    NET EARNINGS AND SHARES OUTSTANDING
    -------------------------------------------------------------------------
                                              Year ended          Year ended
                                       December 31, 2006   December 31, 2005
    -------------------------------------------------------------------------
                                         Total   Per boe     Total   Per boe
    -------------------------------------------------------------------------
    ($000, except per unit amounts)
    -------------------------------------------------------------------------
    Netback                            $80,676    $35.81    $1,762    $13.41
    -------------------------------------------------------------------------
    General & administrative            (3,744)    (1.66)     (921)    (7.01)
    -------------------------------------------------------------------------
    Stock-based compensation            (3,628)    (1.61)     (124)    (0.95)
    -------------------------------------------------------------------------
    Finance charges                        (88)    (0.04)      (77)    (0.59)
    -------------------------------------------------------------------------
    Foreign exchange (loss) gain          (439)    (0.19)      131      1.00
    -------------------------------------------------------------------------
    Taxes other than income taxes         (655)    (0.29)        -         -
    -------------------------------------------------------------------------
    Depletion, depreciation
     and accretion                      (9,614)    (4.27)     (826)    (6.29)
    -------------------------------------------------------------------------
    Income tax recovery (provision)    (22,614)   (10.04)     (360)    (2.73)
    -------------------------------------------------------------------------
    Net earnings (loss)
     for the period                    $39,894    $17.71     $(415)   $(3.16)
    -------------------------------------------------------------------------
    


    In 2006 the company reported earnings of $39.9 million (2005 - loss of
$415,000), which equates to $1.02 (2005 - $0.02 loss) per basic and $0.80
(2005 - $0.02 loss) per weighted average diluted share outstanding.
    For 2006, the weighted average number of common shares outstanding was
39,132,413 (2005 - 20,721,430). In 2006, 10,823,848 additional shares were
included in the diluted earnings per share calculations related to the
potentially dilutive effect of options and warrants. In 2005, as a result of
the loss incurred in the year no incremental shares were included for the
diluted per share calculations because the effect would be anti-dilutive.
    As at March 19, 2007, the company had the following securities issued and
outstanding:

    
    -   43,898,103 common shares;
    -   6,191,072 warrants; and
    -   2,614,667 stock options
    

    Details of the exercise rights and terms of the warrants and options are
noted in the Consolidated Financial Statements, included in this Annual
Report.

    LIQUIDITY AND CAPITAL RE

SOURCES Cash flow from operations before working capital changes ("cash flow"), cash flow per share and cash flow per boe do not have standardized meanings prescribed by GAAP and therefore may not be comparable to similar measures used by other companies. Cash flow includes all cash flow from operating activities and is calculated before changes in non-cash working capital. The most comparable measure calculated in accordance with GAAP would be net earnings. Cash flow is reconciled with net earnings on the Consolidated Statement of Cash Flows and below. Cash flow per share is calculated by dividing cash flow by the weighted average shares outstanding; cash flow per boe is calculated by dividing cash flow by the quantum of crude oil and natural gas (expressed in boe) sold in the period. Management uses these non-GAAP measurements for its own performance measures and to provide its shareholders and investors with a measurement of the company's efficiency and its ability to fund a portion of its future growth expenditures. Reconciliation of net earnings (loss) to cash flow from operations before working capital changes: ------------------------------------------------------------------------- Year ended December 31 2006 2005 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Net earnings (loss) for the period $39,894 $(415) ------------------------------------------------------------------------- Add (deduct) ------------------------------------------------------------------------- Stock-based compensation 3,628 124 ------------------------------------------------------------------------- Depletion, depreciation, and accretion 9,614 826 ------------------------------------------------------------------------- Future income tax provision (recovery) (1,209) 30 ------------------------------------------------------------------------- Foreign exchange loss (gain) 439 (131) ------------------------------------------------------------------------- Cash flow from operations before working capital changes $52,366 $434 ------------------------------------------------------------------------- Cash flow from operations in 2006 was $52.4 million (2005 - $434,000) ($1.34 per basic share and $1.05 per diluted share) (2005 - $0.02 per basic share and $0.01 per weighted average diluted share). Capital expenditures in 2006 totaled $36.4 million (2005 - $6.7 million), primarily for seismic expenditures and costs to drill oil wells, completing an oil pipeline and constructing a battery and other facilities in Argentina, and for new projects in Peru. Petrolifera was in a strong financial position at year end 2006 with bouyant cash flow, $51 million of cash, $43 million of working capital and no debt. The company anticipates it can internally finance a much-expanded capital program of $153 million in 2007 from cash flow and working capital without incurring debt during the year. Additional proceeds from the exercise of outstanding warrants, which are significantly in the money, would bring additional cash of approximately $18 million to Petrolifera's treasury. The company's 2007 capital program includes expenditures to satisfy work commitments related to the Peruvian license blocks. The company is well ahead of schedule to meet these requirements and in 2007 expects to complete the geophysical work, prior to drilling wells on each block. The company has sufficient cash balances and cash flow is being generated in Argentina to fund these capital expenditures and funds are being moved among Argentina, Barbados and Peru as required. Sufficient cash is also on hand to satisfy the Argentina tax liabilities, due to be paid in the second quarter of 2007. The company is also well-advanced in discussions and has executed a mandate letter with a recognized international bank for a reserve-based US $100 million revolving credit facility. This would further enhance Petrolifera's liquidity and financial capacity. FINANCING ACTIVITIES In March 2005, the company completed a $7 million private placement financing consisting of seven million common shares and 3.5 million common share purchase warrants. Proceeds of the financing were used as follows: ------------------------------------------------------------------------- As As stated at the actually time of the financing applied ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Gross proceeds $7,000 $7,000 ------------------------------------------------------------------------- Agent commissions and issue costs (779) (747) ------------------------------------------------------------------------- Applied to reduce promissory note payable to Connacher (2,000) (2,000) ------------------------------------------------------------------------- Used in the capital program $4,221 $4,253 ------------------------------------------------------------------------- In November 2005 the company completed a $21.3 million public offering, by way of prospectus, consisting of 12,193,894 units each comprised of one common share and one-half share purchase warrant, with one warrant and $3.00 entitling the holder to acquire one additional common share from treasury until May 8, 2007. Proceeds of the financing were applied as follows: ------------------------------------------------------------------------- As stated in the As Prospectus at time actually of Financing applied ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Gross proceeds (up to) $30,000 $21,339 ------------------------------------------------------------------------- Agent commissions and issue costs (up to) (2,360) (1,797) ------------------------------------------------------------------------- PowerOne success fee (up to) (550) (327) ------------------------------------------------------------------------- Repayment of promissory note and accrued interest (818) (818) ------------------------------------------------------------------------- Used in capital program or working capital $26,272 $18,397 ------------------------------------------------------------------------- The company's only financial instruments are cash and cash equivalents, accounts receivable, accounts payable and income taxes payable; it maintains no off-balance sheet financial instruments. RELATED PARTY TRANSACTIONS AND SIGNIFICANT TRANSACTIONS Under the terms of a Management Services Agreement with Connacher Oil and Gas Limited ("Connacher"), which expires in May 2007, Connacher provides all management, operational, accounting and general and administrative services necessary or appropriate to manage and administer the company. The fee for this service is $15,000 per month. From time to time Connacher also pays bills on behalf of Petrolifera, for which it is reimbursed. In consideration for the assistance provided to Petrolifera in securing two crude oil and natural gas exploration licenses in Peru and for the provision of financial guarantees respecting Petrolifera's annual work commitments in the licensed blocks in 2005, Connacher was granted an option to acquire 200,000 common shares at $0.50 per share and was granted a 10 percent carried working interest ("CWI") through the drilling of the first well on each block. Petrolifera has the right of first purchase of this interest should Connacher elect to sell it at some future date. The CWI is convertible at the holder's election into a two percent gross overriding royalty on each license after the drilling of the first well on each license. These interests became effective upon the issuance of the licenses. The guarantees are limited to amounts specified over the terms of the licenses. Over the next 12 months, the guarantee is limited to US $200,000. Connacher was subsequently indemnified by Petrolifera for this guarantee. In consideration for his expertise and role in assisting the company in securing the two licenses in Peru, an officer of the company received options to purchase 300,000 Common Shares at a price of $0.50 per share, exercisable until February 1, 2010, a single payment of $100,000 and pursuant to an overriding royalty agreement with the company, was granted a three percent gross overriding royalty ("GORR") on each of the two Peruvian blocks. The GORR will vest over three years; one-third vested immediately upon the issuance of the licenses, one-third will vest one year thereafter and the remaining one-third will vest two years after the issuance of the licenses. The company has the right of first purchase of the GORR at fair value should the officer elect to sell it at some future date. In consideration for his expertise and role in assisting the company in securing the two licenses in Peru, another officer of the company received vested options to purchase 300,000 Common Shares at a price of $0.50 per share, exercisable until February 1, 2010 and a success fee of $20,000 upon the closing of the March 2005 private placement financing and a success fee of $40,000 in November 2005 upon the company completing its initial public offering ("IPO") financing. To assist in marketing the March 2005 private placement financing, the company retained PowerOne Capital Markets Limited ("PowerOne") as one of the selling agents. Prior to the March 2005 private placement financing, PowerOne was considered a connected issuer of Petrolifera because, together with its officers, directors and shareholders and associates of such persons, it owned 18 percent of the outstanding shares of the company. PowerOne received a commission for its services. In March 2005, a Consulting Agreement with PowerOne was extended to November 2006 with a fee of $6,000 per month. The agreement has expired. An additional success fee ("PowerOne Success Fee") in the amount of $327,000 was paid to PowerOne upon the company completing its IPO in November 2005. In March 2005 the company granted Connacher the right, without obligation, to participate in future financings to maintain its 40 percent equity interest in Petrolifera. The company has entered into an executive employment agreement with Gary D. Wine with an effective date of March 11, 2005. Under the terms of this agreement, Mr. Wine is entitled to a base salary as determined by the Human Resources Committee of the Board of Directors, an annual bonus which is based upon the achievement of certain targets relating to corporate performance and stock options as granted by the Board of Directors from time to time. The term of the agreement is indefinite. The agreement may be terminated by the company without notice or cause upon the payment of 18 months annual base salary plus one and a half times the average amount of the bonus payments paid to Mr. Wine for the two calendar years prior to the date of termination, plus the sum of $15,000, less applicable withholdings and deductions, representing compensation for the loss of benefits and perquisites (the "Termination Payment"). In the event of a "change of control", as defined in the agreement, Mr. Wine will also be entitled to the Termination Payment. The executive employment agreement also contains standard confidentiality and non-disclosure provisions. SIGNIFICANT ACCOUNTING POLICIES AND APPLICATION OF CRITICAL ACCOUNTING ESTIMATES The significant accounting policies used by the company are described below. Certain accounting policies require that management make appropriate decisions with respect to the formulation of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Changes in these judgments and estimates may have a material impact on the company's financial results and condition. The following discusses such accounting policies and is included in the MD&A to aid the reader in assessing the significant accounting policies and practices of the company and the likelihood of materially different results being reported. Management reviews it estimates regularly. The emergence of new information and changed circumstances may result in changes to estimates which could be material and the company might realize different results from the application of new accounting standards promulgated, from time to time, by various rule-making bodies. The following assessment of significant accounting polices is not meant to be exhaustive. Oil and Gas Reserves Under Canadian Securities Regulators' "National Instrument 51-101-Standards of Disclosure for Oil and Gas Activities" ("NI 51-101") proved reserves are those reserves that can be estimated with a high degree of certainty to be recoverable. In accordance with this definition, the level of certainty should result in at least a 90 percent probability that the quantities actually recovered will equal or exceed the estimated reserves. In the case of probable reserves, which are less certain to be recovered than proved reserves, NI 51-101 states that it must be equally likely that the actual remaining quantities recovered will be greater or less than the sum of the estimated proved plus probable reserves. Possible reserves are those reserves less certain to be recovered than probable reserves. There is at least a 10 percent probability that the quantities actually recovered will exceed the sum of proved plus probable plus possible reserves. The company's oil and gas reserve estimates are made by independent reservoir engineers using all available geological and reservoir data as well as historical production data. Estimates are reviewed and revised as appropriate. Revisions occur as a result of changes in prices, costs, fiscal regimes, reservoir performance or a change in the company's plans. The reserve estimates are also used in determining the company's borrowing base for its credit facilities and may impact the same upon revision or changes to the reserve estimates. The effect of changes in proved oil and gas reserves on the financial results and position of the company is described under the heading "Full Cost Accounting for Oil and Gas Activities". Full Cost Accounting for Oil and Gas Activities The company uses the full cost method of accounting for exploration and development activities. In accordance with this method of accounting, all costs associated with exploration and development are capitalized whether successful or not. The aggregate of net capitalized costs and estimated future development costs is amortized using the unit-of-production method based on estimated proved oil and gas reserves. Major Development Projects and Unproved Properties Certain costs related to major development projects and unproved properties are excluded from net capitalized costs subject to depletion until proved reserves have been determined, the project becomes commercial, or their value is impaired. These costs are reviewed quarterly and any impairment is transferred to the costs being depleted or, if the properties are located in a cost centre where there is no reserve base, the impairment is charged directly to income. Full Cost Accounting Ceiling Test The company is required to review the carrying value of all property, plant and equipment, including the carrying value of oil and gas assets, for potential impairment. Impairment is indicated if the carrying value of the long-lived asset or oil and gas cost centre is not recoverable by the future undiscounted cash flows. If impairment is indicated, the amount by which the carrying value exceeds the estimated fair value of the long-lived asset is charged to earnings. The ceiling test is based on estimates of reserves, production rate, petroleum and natural gas prices, future costs and other relevant assumptions. By their nature these estimates are subject to measurement uncertainty and the impact on the consolidated financial statements could be material. Asset Retirement Obligations The company is required to provide for future removal and site restoration costs by estimating these costs in accordance with existing laws, contracts or other policies. These estimated costs are charged to earnings and the appropriate liability account over the expected service life of the asset. When the future removal and site restoration costs cannot be reasonably determined, a contingent liability may exist. Contingent liabilities are charged to earnings only when management is able to determine the amount and the likelihood of the future obligation. The company estimates future retirement costs based on current estimates adjusted for inflation and credit risk. These estimates are subject to measurement uncertainty. Income Taxes The company follows the liability method of accounting for income taxes. Under this method tax assets are recognized when it is more than likely realization will occur. Tax liabilities are recognized for temporary differences between recorded book values and underlying tax values. Rates used to determine income tax asset and liability amounts are enacted rates expected to be used in future periods when the timing differences change. The period in which a timing difference reverses are impacted by future income and capital expenditures. Rates are also affected by legislation changes. Stock-Based Compensation The company uses the fair value method to account for stock options. The determination of the amounts for stock-based compensation is based on assumptions of stock volatility, interest rates and the term of the option. These assumptions by their nature are subject to measurement uncertainty. Legal, Environment Remediation and Other Contingent Matters In respect of these matters, the company is required to determine whether a loss is probable based on judgment and interpretation of laws and regulations and determine if such a loss can be estimated. When any such loss is determined, it is charged to earnings. Management continually monitors known and potential contingent matters and makes appropriate provisions by charges to earnings when warranted by circumstance. NEW SIGNIFICANT ACCOUNTING POLICIES Foreign currency translation Business conducted in Peru is considered to be an "integrated foreign operation" for accounting purposes and, therefore, its financial statements are translated into Canadian dollars using the temporal method. Under the temporal method, the company translates foreign denominated monetary assets and liabilities at the exchange rate prevailing at year end; non-monetary assets, liabilities and related depletion and depreciation are translated at historic rates; revenues and expenses are translated at the average rate of exchange for the period; and any resulting foreign exchange gains or losses are included in operations. Due to the significant increase in cash flow generated in Argentina in the second quarter of 2006, the company determined its Argentinean activities comprise a self-sustaining operation. This necessitated a change in the way the Argentinean operations were translated into Canadian dollars for reporting purposes. Previously the Argentinean operations were considered to be integrated with the Canadian operations and were translated using the temporal method described above. As a self-sustaining foreign operation, the Argentinean financial statements are translated into Canadian dollars using the current rate method, whereby assets and liabilities are translated now at the rate of exchange in effect at the balance sheet date; revenues and expenses are translated at the average monthly rates of exchange during the period; and gains or losses on translation are included in a cumulative translation adjustment account in shareholders' equity. This change in accounting practice was adopted prospectively on June 1, 2006 and resulted in a decrease to property, plant and equipment of $597,000 and a decrease to asset retirement obligation of $46,000, which resulted in a net operating foreign currency translation adjustment of $551,000. In the second quarter of 2006, the translation loss was $548,000 which was then recorded to the cumulative translation adjustment account ("CTA"). Since adoption of this change, the impact on CTA for the year ended December 31, 2006 was a gain of $2,218,000. IMPACT OF NEW AND PROPOSED ACCOUNTING PRONOUNCEMENTS The company has assessed new and revised accounting pronouncements that have been issued but that are not yet effective and has determined that the following may have a significant impact on the company. Beginning with the year ending December 31, 2007 the company will be required to adopt, if applicable, the Canadian Institute of Chartered Accountants ("CICA") Section 1530, 3251, 3855 and 3865 on "Comprehensive Income", "Equity", "Financial Instruments - Recognition and Measurement", and "Hedges" respectively, all of which were issued in January 2005. Under the new standards additional financial statement disclosure, namely Consolidated Statement of Other Comprehensive Income, has been introduced that will identify certain gains and losses, including the foreign currency translation adjustments and other amounts arising from changes in fair value, to be temporarily recorded outside the income statement. In addition, all financial instruments, including derivatives, are to be included in the company's Consolidated Balance Sheet and measured, in most cases, at fair values. Requirements for hedge accounting have been further clarified. Although Petrolifera is in the process of evaluating the impact of these standards, the company does not expect these new standards to have a material impact on its Consolidated Financial Statements. Over the next five years the CICA will adopt its new strategic plan for the direction of accounting standards in Canada, which was ratified in January 2006. As part of the plan, Canadian GAAP for public companies will converge with International Financial Reporting Stands ("IFRS") over the next five years. The company continues to monitor and assess the impact of the convergence of Canadian GAAP with IFRS. COMMITMENTS, CONTINGENCIES, GUARANTEES, CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS In 2005 Petrolifera acquired two significant oil and gas exploration licenses in Peru. The licenses have a total US$41.8 million financial commitment to complete negotiated work programs on the two licenses over seven years. The company has the right to withdraw from the licenses at the end of each period associated with the term of the licenses. The first license term will end in 2007 and the company has already met its commitment to invest US$1 million. In the second license term, the company is committed to invest a total of US$4.6 million between 2007 and 2009. These expenditures are budgeted to be fully discharged in 2007. The company issued letters of credit in the amount of US$200,000 to secure the capital expenditure requirements associated with the two exploration licenses. Additionally, the company has various guarantees and indemnifications in place in the ordinary course of business, none of which are expected to have a significant impact on the company's financial statements or operations. The company's annual commitments under contracts for drilling services, leases for office premises and operating costs, software license agreements and other equipment are as follows: ------------------------------------------------------------------------- Sub- 2008- 2011- sequent Contractual Obligations 2007 2010 2012 to 2012 Total ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Asset retirement obligations - - - 2,347 2,347 Service contracts 12,505 11,703 - - 24,208 ------------------------------------------------------------------------- Total 12,505 11,703 - 2,347 26,555 ------------------------------------------------------------------------- The company has no off balance sheet financing arrangements DISCLOSURE CONTROLS AND PROCEDURES Disclosure controls and procedures have been designed to ensure that information required to be disclosed by the company is accumulated, recorded, processed and reported to the company's management as appropriate to allow timely decisions regarding required disclosure. The company's Executive Chairman and Interim Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by this MD&A, that the company's disclosure controls and procedures as of the end of such period are effective to provide reasonable assurance that material information related to the company, including its consolidated subsidiaries, is communicated to them as appropriate to allow timely decisions regarding required disclosure. INTERNAL CONTROL OVER FINANCIAL REPORTING Management of the company is responsible for designing adequate internal controls over the company's financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP. Management assessed the design of the company's internal controls over financial reporting as of December 31, 2006 and based on that assessment, determined that the company's internal controls over financial reporting were adequately designed. It should be noted that while the company's Executive Chairman and Interim Chief Financial Officer believe that the company's disclosure controls and procedures provide a reasonable level of assurance that they are effective, and that the internal controls over financial reporting are adequately designed, they do not expect that the financial disclosure controls and procedures or internal control over financial reporting will prevent all errors and fraud. A control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. BUSINESS RISKS Petrolifera is exposed to certain risks and uncertainties inherent in the oil and gas business. Furthermore, being a smaller independent company, it is exposed to financing and other risks which may impair its ability to realize on its assets or to capitalize on opportunities which might become available to it. Additionally, Petrolifera operates in various foreign jurisdictions and is exposed to other risks including currency fluctuations, political risk, price controls and varying forms of fiscal regimes or changes thereto which may impair Petrolifera's ability to conduct profitable operations. The risks arising in the oil and gas industry include price fluctuations for both crude oil and natural gas over which the company has limited control; risks arising from exploration and development activities; production risks associated with the depletion of reservoirs and the ability to market production. Additional risks include environmental and safety concerns. The success of the company's capital programs as embodied in its productivity and reserve base could also impact its prospective liquidity and pace of future activities. Control of finding, development, operating and overhead costs per boe is an important criterion in determining company growth, success and access to new capital sources. To date, the company has utilized equity financing and has had a bias towards conservatively financing its operations under normal industry conditions to offset the inherent risks of domestic and international oil and gas exploration, development and production activities. The company is currently negotiating with an international bank for a credit facility that would provide the company with additional financial flexibility to fund its future growth. From time to time, the company may have to access capital markets for new equity to supplement internally generated cash flow and bank borrowings to finance its growth plans. Periodically, these markets may not be receptive to offerings of new equity from treasury, whether by way of private placement or public offerings. This may be further complicated by the limited market liquidity for shares of smaller companies, restricting access to some institutional investors. Periodic fluctuations in energy prices may also affect lending policies of the company's banker, for new borrowings. This in turn could limit growth prospects over the short run or may even require the company to dedicate cash flow, dispose of properties or raise new equity to reduce bank borrowings under circumstances of declining energy prices or disappointing drilling results. While hedging activities may have opportunity costs when realized prices exceed hedged pricing, such transactions are not meant to be speculative and are considered within the broader framework of financial stability and flexibility. Management continuously reviews the need to utilize such financing techniques. The company attempts to mitigate its business and operational risk exposures by maintaining comprehensive insurance coverage on its assets and operations, by employing or contracting competent technicians and professionals, by instituting and maintaining operational health, safety and environmental standards and procedures and by maintaining a prudent approach to exploration and development activities. The company also addresses and regularly reports on the impact of risks to its shareholders, writing down the carrying values of assets that may not be recoverable. OUTLOOK The company's business plan contemplates continued aggressive growth. To accomplish this, the company expects an active capital program of oil and gas exploration and development drilling in 2007. Forecast operating cash flow from growing production and available cash should be sufficient to finance Petrolifera's expected 2007 capital spending program, which has been established at $153 million. All capital program expenditures are discretionary, except for a total of $US4.6 million for which the company is obligated between the years 2007 and 2009, pursuant to the terms of the Peruvian exploration licenses. A summary of the company's original 2007 financial plan and budget is contained in an investor presentation dated October 2006 as posted on its website under Investor Info/Presentations at www.petrolifera.ca. The company reserves the right to alter or amend its guidance throughout the year and will communicate such amendments, if material, by way of press release to the public. All estimates and statements which may have been issued are forward-looking statements. This involves inherent risks and uncertainties where actual results will differ and such differences could be material. There can be no assurance that Petrolifera will achieve the drilling results and levels of production it might assume in developing its internal capital budget and financial plan. In addition, oil and gas prices are subject to fluctuation and there can be no assurance that the prices assumed for the company's internal plan, or any variation thereof, will be attained. QUARTERLY RESULTS ------------------------------------------------------------------------- 2005 ------------------------------------------------------------------------- Three months ended ------------------------------------------------------------------------- Mar 31 June 30 Sept 30 Dec 31 ------------------------------------------------------------------------- Financial results ($000 except per share amounts) - unaudited ------------------------------------------------------------------------- Total revenue 385 477 517 1,485 ------------------------------------------------------------------------- Cash flow from operations before working capital changes(1) 73 77 56 228 ------------------------------------------------------------------------- Basic, per share(1) - 0.01 - 0.01 ------------------------------------------------------------------------- Diluted, per share(1) - 0.01 - 0.01 ------------------------------------------------------------------------- Earnings (loss) for the period (75) (161) 5 (184) ------------------------------------------------------------------------- Basic, per share - (0.01) - (0.01) ------------------------------------------------------------------------- Diluted, per share - (0.01) - (0.01) ------------------------------------------------------------------------- Capital expenditures 1,295 245 650 4,472 ------------------------------------------------------------------------- Cash on hand 3,420 3,237 2,315 19,744 ------------------------------------------------------------------------- Working capital surplus 3,112 2,222 44 17,887 ------------------------------------------------------------------------- Indebtedness 750 750 750 - ------------------------------------------------------------------------- Shareholders' equity 6,881 6,738 6,766 27,060 ------------------------------------------------------------------------- Total assets 8,688 8,530 9,251 31,581 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Operating results ------------------------------------------------------------------------- Production / sales volumes ------------------------------------------------------------------------- Crude oil - bbl/d 85 86 84 324 ------------------------------------------------------------------------- Natural gas - mcf/d 1,209 1,381 1,273 1,285 ------------------------------------------------------------------------- Equivalent - boe/d(2) 287 316 296 538 ------------------------------------------------------------------------- Pricing ------------------------------------------------------------------------- Crude oil - $/bbl 39.83 44.84 48.01 43.08 ------------------------------------------------------------------------- Natural gas - $/mcf 0.72 0.86 1.12 0.99 ------------------------------------------------------------------------- Selected highlights - $/boe(2) ------------------------------------------------------------------------- Weighted average selling price per boe 14.91 15.97 18.46 28.31 ------------------------------------------------------------------------- Interest and other income - 0.61 0.51 1.67 ------------------------------------------------------------------------- Royalties 1.70 2.00 2.22 3.85 ------------------------------------------------------------------------- Operating costs 3.43 5.40 6.20 6.78 ------------------------------------------------------------------------- Netback(3) 9.78 9.18 10.57 17.78 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Common share information (000s) ------------------------------------------------------------------------- Shares outstanding at end of period 20,000 20,000 20,000 34,404 ------------------------------------------------------------------------- Fully diluted 30,140 30,140 31,080 51,118 ------------------------------------------------------------------------- Weighted average shares outstanding for the period ------------------------------------------------------------------------- Basic 14,633 20,000 20,000 20,721 ------------------------------------------------------------------------- Diluted 18,309 23,676 23,676 31,803 ------------------------------------------------------------------------- Volume traded during quarter (000) ------------------------------------------------------------------------- Common share price ($) ------------------------------------------------------------------------- High ------------------------------------------------------------------------- Low ------------------------------------------------------------------------- Close (end of period) ------------------------------------------------------------------------- ------------------------------------------------------------------------- 2006 ------------------------------------------------------------------------- Three months ended ------------------------------------------------------------------------- Mar 31 June 30 Sept 30 Dec 31 ------------------------------------------------------------------------- Financial results ($000 except per share amounts) - unaudited ------------------------------------------------------------------------- Total revenue 8,452 18,821 33,157 45,153 ------------------------------------------------------------------------- Cash flow from operations before working capital changes(1) 3,435 9,470 18,384 21,077 ------------------------------------------------------------------------- Basic, per share(1) 0.10 0.25 0.46 0.53 ------------------------------------------------------------------------- Diluted, per share(1) 0.07 0.19 0.38 0.49 ------------------------------------------------------------------------- Earnings (loss) for the period 1,543 7,685 15,683 14,983 ------------------------------------------------------------------------- Basic, per share 0.04 0.21 0.39 0.38 ------------------------------------------------------------------------- Diluted, per share 0.03 0.16 0.32 0.29 ------------------------------------------------------------------------- Capital expenditures 2,321 2,310 9,738 22,031 ------------------------------------------------------------------------- Cash on hand 21,999 25,941 36,206 51,008 ------------------------------------------------------------------------- Working capital surplus 21,959 28,913 41,361 43,038 ------------------------------------------------------------------------- Indebtedness - - - - ------------------------------------------------------------------------- Shareholders' equity 32,991 40,844 61,440 80,656 ------------------------------------------------------------------------- Total assets 38,989 52,760 81,226 118,517 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Operating results ------------------------------------------------------------------------- Production / sales volumes ------------------------------------------------------------------------- Crude oil - bbl/d 1,855 4,006 7,202 10,716 ------------------------------------------------------------------------- Natural gas - mcf/d 1,243 1,181 1,259 1,101 ------------------------------------------------------------------------- Equivalent - boe/d(2) 2,062 4,203 7,412 10,900 ------------------------------------------------------------------------- Pricing ------------------------------------------------------------------------- Crude oil - $/bbl 48.90 50.71 49.49 45.20 ------------------------------------------------------------------------- Natural gas - $/mcf 1.17 1.33 1.44 1.50 ------------------------------------------------------------------------- Selected highlights - $/boe(2) ------------------------------------------------------------------------- Weighted average selling price per boe 44.70 48.71 48.33 44.59 ------------------------------------------------------------------------- Interest and other income 0.84 0.50 0.30 0.44 ------------------------------------------------------------------------- Royalties 5.74 7.20 6.73 6.37 ------------------------------------------------------------------------- Operating costs 4.52 4.42 5.21 4.02 ------------------------------------------------------------------------- Netback(3) 35.28 37.59 36.69 34.64 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Common share information (000s) ------------------------------------------------------------------------- Shares outstanding at end of period 37,100 37,855 42,817 43,612 ------------------------------------------------------------------------- Fully diluted 52,172 52,172 52,671 52,704 ------------------------------------------------------------------------- Weighted average shares outstanding for the period ------------------------------------------------------------------------- Basic 36,036 37,399 40,442 43,418 ------------------------------------------------------------------------- Diluted 47,500 48,777 48,594 51,002 ------------------------------------------------------------------------- Volume traded during quarter (000) 26,745 8,697 16,732 18,086 ------------------------------------------------------------------------- Common share price ($) ------------------------------------------------------------------------- High 13.75 12.60 21.95 25.24 ------------------------------------------------------------------------- Low 6.55 8.15 10.92 14.71 ------------------------------------------------------------------------- Close (end of period) 12.25 11.00 20.90 17.65 ------------------------------------------------------------------------- (1) Cash flow from operations before working capital changes ("cash flow") and cash flow per share do not have standardized meanings prescribed by Canadian generally accepted accounting principles ("GAAP") and therefore may not be comparable to similar measures used by other companies. Cash flow from operations before working capital changes includes all cash flow from operating activities and is calculated before changes in non-cash working capital. The most comparable measure calculated in accordance with GAAP would be net earnings. Cash flow from operations before working capital changes is reconciled with net earnings on the Consolidated Statement of Cash Flows and in the accompanying Management's Discussion & Analysis. Management uses these non-GAAP measurements for its own performance measures and to provide its shareholders and investors with a measurement of the company's efficiency and its ability to fund a portion of its future growth expenditures. (2) All references to barrels of oil equivalence (boe) are calculated on the basis of 6 mcf : 1 bbl. Boe may be misleading particularly if used in isolation. This conversion is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalent at the wellhead. (3) Netback is a non-GAAP measure used by management as a measure of operating efficiency and profitability. It is calculated as petroleum and natural gas revenue and other income less royalties and operating costs. CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS Petrolifera Petroleum Limited December 31 ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- $000 ------------------------------------------------------------------------- ASSETS ------------------------------------------------------------------------- Current ------------------------------------------------------------------------- Cash and cash equivalents $51,008 $19,744 ------------------------------------------------------------------------- Accounts receivable 26,868 2,060 ------------------------------------------------------------------------- Prepaid expenses 302 136 ------------------------------------------------------------------------- Inventories (Note 4) 374 - ------------------------------------------------------------------------- 78,552 21,940 ------------------------------------------------------------------------- Future income tax asset (Note 5) 2,150 941 ------------------------------------------------------------------------- Property and equipment (Note 6) 37,815 8,700 ------------------------------------------------------------------------- $118,517 $31,581 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES ------------------------------------------------------------------------- Current ------------------------------------------------------------------------- Accounts payable and accrued liabilities $14,066 $3,559 ------------------------------------------------------------------------- Income taxes payable 21,416 274 ------------------------------------------------------------------------- Due to a related company (Note 9) 32 221 ------------------------------------------------------------------------- 35,514 4,054 ------------------------------------------------------------------------- Asset retirement obligations (Note 7) 2,347 467 ------------------------------------------------------------------------- 37,861 4,521 ------------------------------------------------------------------------- ------------------------------------------------------------------------- SHAREHOLDERS' EQUITY ------------------------------------------------------------------------- Share capital, warrants and contributed surplus (Note 8) 39,275 27,240 ------------------------------------------------------------------------- Cumulative translation adjustment 1,667 - ------------------------------------------------------------------------- Retained earnings (deficit) 39,714 (180) ------------------------------------------------------------------------- 80,656 27,060 ------------------------------------------------------------------------- $118,517 $31,581 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Commitments, contingencies and guarantees (Note 12) Approved by the board Signed, Signed, "C.J. Smith" "D.D. Barkwell" Director Director CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS (DEFICIT) Petrolifera Petroleum Limited Years Ended December 31 ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- $000 ------------------------------------------------------------------------- Revenue ------------------------------------------------------------------------- Petroleum and natural gas sales $104,595 $2,750 ------------------------------------------------------------------------- Interest and other income 988 114 ------------------------------------------------------------------------- 105,583 2,864 ------------------------------------------------------------------------- Royalties (14,796) (353) ------------------------------------------------------------------------- 90,787 2,511 ------------------------------------------------------------------------- Expenses ------------------------------------------------------------------------- Operating 10,111 749 ------------------------------------------------------------------------- General and administrative 3,744 921 ------------------------------------------------------------------------- Stock-based compensation 3,628 124 ------------------------------------------------------------------------- Finance charges 88 77 ------------------------------------------------------------------------- Foreign exchange (gain) loss 439 (131) ------------------------------------------------------------------------- Taxes other than income taxes 655 - ------------------------------------------------------------------------- Depletion, depreciation and accretion 9,614 826 ------------------------------------------------------------------------- 28,279 2,566 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Earnings (loss) before income taxes 62,508 (55) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Current income tax provision (Note 5) 23,823 330 ------------------------------------------------------------------------- Future income tax provision (recovery) (Note 5) (1,209) 30 ------------------------------------------------------------------------- 22,614 360 ------------------------------------------------------------------------- ------------------------------------------------------------------------- NET EARNINGS (LOSS) 39,894 (415) ------------------------------------------------------------------------- ------------------------------------------------------------------------- DEFICIT, BEGINNING OF YEAR (180) (1,019) ------------------------------------------------------------------------- Elimination of deficit (Note (8(f)) - 1,254 ------------------------------------------------------------------------- ------------------------------------------------------------------------- RETAINED EARNINGS (DEFICIT), END OF YEAR $39,714 $(180) ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- NET EARNINGS (LOSS) PER SHARE (Note 11) ------------------------------------------------------------------------- Basic $1.02 $(0.02) ------------------------------------------------------------------------- Diluted $0.80 $(0.02) ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS Petrolifera Petroleum Limited Years Ended December 31 ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- $000 ------------------------------------------------------------------------- Cash provided by (used in) the following activities: ------------------------------------------------------------------------- ------------------------------------------------------------------------- Operating ------------------------------------------------------------------------- Net earnings (loss) $39,894 $(415) ------------------------------------------------------------------------- Items not involving cash: ------------------------------------------------------------------------- Depletion, depreciation and accretion 9,614 826 ------------------------------------------------------------------------- Stock-based compensation 3,628 124 ------------------------------------------------------------------------- Foreign exchange (gain) loss 439 (131) ------------------------------------------------------------------------- Future income tax provision (1,209) 30 ------------------------------------------------------------------------- Cash flow from operations before working capital changes 52,366 434 ------------------------------------------------------------------------- Changes in non-cash working capital (Note 11) 1,317 (704) ------------------------------------------------------------------------- 53,683 (270) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Financing ------------------------------------------------------------------------- Issue of common shares, net of share issue costs 8,407 26,642 ------------------------------------------------------------------------- Repayment of promissory note - (2,750) ------------------------------------------------------------------------- 8,407 23,892 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Investing ------------------------------------------------------------------------- Development of oil and gas properties (36,400) (6,662) ------------------------------------------------------------------------- Changes in non-cash working capital (Note 11) 4,796 2,625 ------------------------------------------------------------------------- (31,604) (4,037) ------------------------------------------------------------------------- INCREASE IN CASH AND CASH EQUIVALENTS 30,486 19,585 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 19,744 159 ------------------------------------------------------------------------- Impact of foreign exchange on foreign currency denominated cash balances 778 - ------------------------------------------------------------------------- ------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS, END OF YEAR $51,008 $19,744 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS IS COMPOSED OF: ------------------------------------------------------------------------- Cash in banks $18,345 $1,036 ------------------------------------------------------------------------- Term deposits 32,663 18,708 ------------------------------------------------------------------------- $51,008 $19,744 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Supplementary information - Note 11 ------------------------------------------------------------------------- NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Petrolifera Petroleum Limited Years ended December 31, 2006 and December 31, 2005 1. INCORPORATION Petrolifera Petroleum Limited ("Petrolifera" or the "company") was incorporated on November 9, 2004. Through subsidiaries and foreign branches, it is engaged in petroleum and natural gas exploration, development and production activities in South America. 2. FINANCIAL STATEMENT PRESENTATION The financial statements include the accounts of the company and its subsidiaries and are presented in Canadian dollars and in accordance with Canadian generally accepted accounting principles. 3. SIGNIFICANT ACCOUNTING POLICIES Cash and cash equivalents Cash and cash equivalents include short-term deposits with initial maturities of three months or less when purchased. Inventory Crude oil inventory is measured at the lower of cost on a weighted average cost basis and net realizable value. Income taxes The company follows the liability method of accounting for income taxes. Under this method, income tax liabilities and assets are recognized for the estimated tax consequences attributed to differences between the amounts reported in the financial statements and their respective tax bases, using substantively enacted income tax rates. The effect of a change in income tax rates on future income tax liabilities and assets is recognized in income in the period that the change occurs. Future tax assets are assessed by management at each balance sheet date and recognized when realization is probable. Petroleum and natural gas operations The company follows the full cost method of accounting whereby all costs relating to the exploration for and development of crude oil and natural gas reserves are capitalized on a country by country cost centre basis. Capitalized costs of petroleum and natural gas properties and related equipment within a cost centre are depleted and depreciated using the unit-of-production method based on estimated proved crude oil and natural gas reserves as determined by independent consulting engineers. For the purpose of this calculation, production and reserves of natural gas are converted to equivalent units of crude oil based on relative energy content (6:1). The company applies a "ceiling test" to the net book value of petroleum and natural gas properties for each cost centre to ensure that such carrying value does not exceed the estimated fair value of the properties. The carrying value is assessed to be recoverable when the sum of the undiscounted cash flows expected from the production of proved reserves and the lower of cost, less impairment, of unproved properties exceeds the carrying value. If the carrying value is assessed to not be recoverable, the calculation compares the carrying value to the sum of the discounted cash flows expected from the production of proved and probable reserves and the lower of cost, less impairment, of unproved properties. Should the carrying value exceed this sum, an impairment loss is recognized. The cash flows are estimated using projected future product prices and costs and are discounted using the credit adjusted risk-free interest rate. Costs of acquiring and evaluating unproved properties and major development projects are excluded from costs subject to depletion and depreciation until it is determined whether or not proved reserves are attributable to the properties, the project becomes commercial, or impairment occurs. These costs are reviewed quarterly and any impairment is transferred to the costs being depleted or, if the properties are located in a cost centre where there is no reserve base, the impairment is charged directly to income. Gains or losses on sales of properties are recognized only when crediting the proceeds to cost would result in a change of 20 percent or more in the depletion and depreciation rate. Asset retirement obligations The company provides for the costs of retirement obligations associated with long-lived assets, including the abandonment of oil and natural gas wells, related facilities, compressors and gas plants, removal of equipment from leased acreage and returning such land to its original condition. The estimated fair value of each asset retirement obligation is recorded in the period a well or related asset is drilled, constructed or acquired. Fair value is estimated using the present value of the estimated future cash outflows to abandon the asset using the company's credit adjusted risk-free interest rate and expected inflation rate. The obligation is reviewed regularly by management based upon current regulations, costs, technologies and industry standards. The discounted obligation is initially capitalized as part of the carrying amount of the related oil and natural gas properties and a corresponding liability is recognized. The liability is accreted against income until it is settled or the property is sold and is included as a component of depletion and depreciation expense. The increase in oil and natural gas properties is depleted and depreciated on the same basis as the remainder of the oil and natural gas properties. Actual restoration expenditures are charged to the accumulated obligation as incurred. Foreign operations The company is exposed to foreign currency fluctuations, political risks, price controls and varying forms of fiscal regimes or changes thereto which may impair its ability to conduct profitable operations as it operates internationally and holds foreign denominated cash and other assets. Revenue recognition Petroleum and natural gas sales are recognized as revenue at the time the respective commodities are delivered to purchasers at the point of sale. Stock-based compensation The company uses the fair value method for valuing stock option grants. Compensation costs attributed to share options granted are measured at fair value at the grant date and expensed over the vesting period with a corresponding increase to contributed surplus. Upon exercise of the stock options, consideration paid by the option holder together with the amount previously recognized in contributed surplus is recorded as an increase to share capital. Financial instruments Financial instruments include cash and cash equivalents, accounts receivable, accounts payable, and amount due to a related company. All carrying values of financial instruments approximate fair values due to their short-term maturities. Credit risk The majority of the accounts receivable is in respect of sales of petroleum and natural gas. The company generally extends unsecured credit to customers and therefore, the collection of accounts receivable may be affected by changes in economic or other conditions. Management believes the risk is mitigated by the size and reputation of the companies to which credit has been extended. Commodity risk The company is exposed to fluctuations in commodity prices and has no contracts in place to mitigate these exposures. Measurement uncertainty The timely preparation of the financial statements in conformity with Canadian generally accepted accounting principles requires that management make estimates and assumptions and use judgment regarding the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Such estimates primarily relate to unsettled transactions and events as of the date of the consolidated financial statements. Accordingly, actual results may differ from estimated amounts as future confirming events occur. Amounts recorded for depreciation, depletion and accretion, amounts used for ceiling test and impairment calculations and amounts used in the determination of the future tax asset are based on estimates of natural gas and crude oil reserves and future costs required to develop those reserves. By their nature, these estimates of reserves, including the estimates of future prices and costs, and the related future cash flows are subject to measurement uncertainty. Per share amounts Basic per share amounts are calculated using the weighted average number of common shares outstanding for the period. The company follows the treasury stock method to calculate diluted per share amounts. The treasury stock method assumes that any proceeds from the exercise of in-the-money stock purchase warrants and other dilutive instruments, in addition to stock-based compensation not yet recognized, would be used to purchase common shares at the average market price during the period. Foreign currency translation Business conducted in Peru is considered to be an "integrated foreign operation" for accounting purposes and, therefore, its financial statements are translated into Canadian dollars using the temporal method. Under the temporal method, the company translates foreign denominated monetary assets and liabilities at the exchange rate prevailing at year end; non-monetary assets, liabilities and related depletion and depreciation are translated at historic rates; revenues and expenses are translated at the average rate of exchange for the period; and any resulting foreign exchange gains or losses are included in operations. Due to the significant increase in cash flow generated in Argentina in the second quarter of 2006, the company determined its Argentinean activities comprise a self-sustaining operation. This necessitated a change in the way the Argentinean operations were translated into Canadian dollars for reporting purposes. Previously the Argentinean operations were considered to be integrated with the Canadian operations and were translated using the temporal method described above. As a self-sustaining foreign operation, the Argentinean financial statements are translated into Canadian dollars using the current rate method, whereby assets and liabilities are translated now at the rate of exchange in effect at the balance sheet date; revenues and expenses are translated at the average monthly rates of exchange during the period; and gains or losses on translation are included in a cumulative translation adjustment account in shareholders' equity. This change in accounting practice was adopted prospectively on June 1, 2006 and resulted in a decrease to property, plant and equipment of $597,000 and a decrease to asset retirement obligation of $46,000, which resulted in a net operating foreign currency translation adjustment of $551,000. Since adoption of this change, the impact on the cumulative translation adjustment account ("CTA") for the year ended December 31, 2006 was a gain of $2,218,000. 4. INVENTORIES The company maintains inventory as a consequence of the sales process for its products, whereby crude oil which has been produced is not delivered to customers for periods of up to several days, during which time it must be stored. ------------------------------------------------------------------------- Years ended December 31 2006 2005 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Crude oil $374 $ - ------------------------------------------------------------------------- At December 31, 2006 inventory is composed of crude oil held in storage at the company's facilities and in transportation pipelines. 5. INCOME TAXES The following table reconciles income taxes calculated at the Canadian statutory rate with recorded income taxes: ------------------------------------------------------------------------- Years ended December 31 2006 2005 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Earnings (loss) before income taxes $62,508 $(55) ------------------------------------------------------------------------- Statutory income tax rate 32.2% 37.9% ------------------------------------------------------------------------- Expected income tax (recovery) $20,128 $(21) ------------------------------------------------------------------------- Non deductible expenditures and foreign taxes 1,686 366 ------------------------------------------------------------------------- Stock compensation 1,167 47 ------------------------------------------------------------------------- Rate adjustment and other (367) (32) ------------------------------------------------------------------------- Tax expense $22,614 $360 ------------------------------------------------------------------------- Future tax assets relate to the following temporary timing differences: ------------------------------------------------------------------------- Years ended December 31 2006 2005 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Property and equipment $(717) $597 Operating losses 645 180 Share issue costs 524 1,210 Future foreign tax credit 1,127 - Asset retirement obligation 644 - Valuation allowance (73) (1,046) ------------------------------------------------------------------------- Future tax asset $2,150 $941 ------------------------------------------------------------------------- 6. PROPERTY AND EQUIPMENT ------------------------------------------------------------------------- Accumulated Depletion and Deprec- Net Book Cost iation Value ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- As at December 31, 2006 Petroleum and natural gas properties and equipment $47,803 $10,445 $37,358 Furniture, equipment and leaseholds 523 66 457 ------------------------------------------------------------------------- $48,326 $10,511 $37,815 ------------------------------------------------------------------------- As at December 31, 2005 Petroleum and natural gas properties and equipment $9,489 $835 $8,655 Furniture, equipment and leaseholds 67 22 45 ------------------------------------------------------------------------- $9,556 $857 $8,700 ------------------------------------------------------------------------- Included in property and equipment are estimated future asset retirement costs of $2.3 million (2005 - $427,000). In 2006, the company capitalized $716,000 (2005 - $164,000) of general and administrative expenses related to exploration and development activities. Capital costs of $6.4 million (2005 - $780,000) incurred for unevaluated properties in Argentina and for major development projects and other assets in a pre-production stage located mainly in Peru, have been excluded from depletable costs. No proved reserves have been assigned to those projects. Depletion, depreciation and accretion expense includes a charge of $27,000 (2005 - $25,000) to accrete the company's estimated asset retirement obligations (Note 7). The ceiling test as at December 31, 2006 excludes $6.4 million (2005 - $780,000) for major development projects which have been separately evaluated by management for impairment. Based on the ceiling test and other assessments, no impairment has been recorded at December 31, 2006 or 2005. Petrolifera's petroleum and natural gas reserves were evaluated by independent reservoir engineers as at December 31, 2006 in a report dated March 6, 2007. The evaluation was conducted in accordance with Canadian Securities Administrators' National Instrument 51-101, using the following price assumptions: ------------------------------------------------------------------------- Crude Oil Price Natural Gas Price ($CDN/bbl) ($CDN/mcf) ------------------------------------------------------------------------- 2007 46.64 2.39 2008 45.94 2.44 2009 45.24 2.49 2010 44.89 2.54 2011 44.89 2.59 ------------------------------------------------------------------------- + approximately 1% + approximately 2% thereafter thereafter ------------------------------------------------------------------------- 7. ASSET RETIREMENT OBLIGATIONS At December 31, 2006 the estimated total undiscounted amount required to settle the asset retirement obligations was $6.3 million (2005 - $751,000). These obligations are expected to be settled over the useful lives of the underlying assets, which currently extend up to 20 years into the future. This amount has been discounted using a credit-adjusted risk-free interest rate of six percent and an annual inflation rate of two percent. Changes to asset retirement obligations were as follows: ------------------------------------------------------------------------- Years ended December 31 2006 2005 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Asset retirement obligations, beginning of year $467 $422 Liabilities incurred 1,853 51 Changes in estimates - (31) Accretion expense 27 25 ------------------------------------------------------------------------- Asset retirement obligations, end of year $2,347 $467 ------------------------------------------------------------------------- 8. SHARE CAPITAL, WARRANTS AND CONTRIBUTED SURPLUS Authorized The authorized share capital is comprised of an unlimited number of common shares. Issued: ------------------------------------------------------------------------- Number Amount of Shares ($000) ------------------------------------------------------------------------- Share capital and warrants: ------------------------------------------------------------------------- Balance, January 1, 2005 13,000,001 $1,421 Issued for cash by private placement (a) 7,000,000 7,000 Issued upon exercise of rights (b) 700,000 - Issued for cash by initial public offering (c) 12,193,894 19,630 Warrants issued for cash by initial public offering 1,710 Issued upon exercise of warrants (d) 1,510,000 1,365 Assigned value of broker compensation warrants exercised 6 Share issue costs (3,084) Tax effect of share issue costs 295 Elimination of deficit (f) (1,254) ------------------------------------------------------------------------- Balance share capital and warrants, December 31, 2005 34,403,895 27,089 Issued upon exercise of warrants in 2006 (d) 8,677,275 7,908 Issued upon exercise of options in 2006 (e) 531,333 654 Assigned value of broker compensation warrants exercised 27 Share issue costs (16) ------------------------------------------------------------------------- Balance, share capital and warrants, December 31, 2006 43,612,503 $35,662 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Contributed surplus: Balance, January 1, 2005 $12 Assigned value of broker compensation warrants exercised 21 Exercise of warrants in 2005 (6) Assigned fair value of stock options granted in 2005 124 ------------------------------------------------------------------------- Balance, contributed surplus, December 31, 2005 151 Assigned value of broker compensation warrants exercised (27) Fair value of options exercised (139) Assigned fair value of stock options granted 3,628 ------------------------------------------------------------------------- Balance, contributed surplus, December 31, 2006 $3,613 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total share capital, warrants and contributed surplus December 31, 2005 $27,240 December 31, 2006 $39,275 ------------------------------------------------------------------------- (a) Private Placement - 2005 In March 2005 the company issued 7 million Units for gross proceeds of $7 million. Each Unit comprised one common share, one-half of one Common Share Purchase Warrant and one Right. Each Common Share Purchase Warrant issued was exercisable anytime before October 17, 2006 at $1.50 to acquire a total of 3,500,000 common shares. All warrants were exercised prior to their expiry. As partial compensation for distributing the Units, selling agents were issued 490,000 Broker Compensation Warrants. Each Broker Compensation Warrant was exercisable anytime before October 17, 2006 at $1.00 to acquire a maximum of 490,000 Broker Units. Each Broker Unit comprised one common share and one-half of one Common Share Purchase Warrant. Each of these Common Share Purchase Warrants issuable was exercisable at $1.50 to acquire a total of 245,000 common shares anytime before October 17, 2006. All Broker Compensation Warrants and all Broker Units were exercised in 2006. For accounting purposes, the common share Purchase Warrants issued were determined to have no assignable fair value using the Black-Scholes option-pricing model. The Broker Compensation Warrants issued had an assignable fair value of $21,400, as calculated using the Black-Scholes option-pricing model. (b) Rights - 2005 Each Right issued to investors in the March 2005 Private Placement financing entitled the holder to receive, without any further action or consideration, an additional 0.1 of a Unit, excluding a Right, for each Unit held in the event that the company had not, before October 11, 2005, either received a receipt for a final prospectus relating to an initial public offering of securities by a securities commission in at least one of the provinces of British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, or Nova Scotia; or completed a share exchange, amalgamation or other business combination resulting in shareholders of the company becoming holders of securities of an entity that was a reporting issuer in at least one of the provinces of British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, or Nova Scotia. Rights were not attached to the Broker Units issuable to the selling agents exercising their Broker Compensation Warrants. For accounting purposes, the Rights were determined to have no assignable fair value using the Black-Scholes option-pricing model. Rights were not attached to the Broker Units issuable to the selling agents exercising their Broker Compensation Warrants. On October 11, 2005, 700,000 common shares and 350,000 Common Share Purchase Warrants were issued pursuant to the Rights. (c) Initial Public Offering ("IPO Financing") - 2005 On November 8, 2005 the company issued 12,193,894 Units for total gross proceeds of $21,339,315. Each Unit comprised one common share and one- half of one Common Share Purchase Warrant (the "IPO Warrants" - 6,096,947 in total), with each IPO Warrant entitling the holder to purchase one common share from treasury at $3.00 any time before May 8, 2007. Pursuant to this financing, the company listed its common shares and the IPO Warrants for trading on the Toronto Stock Exchange. For accounting purposes, the common share Purchase Warrants had an assignable fair value of $1,709,608 as calculated using the Black-Scholes option-pricing model. (d) Common Share Purchase Warrants Transactions in Common Share Purchase Warrants occurred during 2005 and 2006 as follows: ------------------------------------------------------------------------- Opening balance, January 1, 2005 5,350,000 Issued in 2005 10,511,947 Exercised in 2005 (1,510,000) ------------------------------------------------------------------------- Closing balance, December 31, 2005 14,351,947 Issued upon exercise of Broker Compensation Warrants in 2006 520,000 Exercised in 2006 (8,677,275) ------------------------------------------------------------------------- Closing balance, December 31, 2006 6,194,672 ------------------------------------------------------------------------- In 2006 the following warrants were exercised: - 3,985,000 Common Share Purchase Warrants at $0.40 per share resulting in the issuance of 3,985,000 common shares; - 3,240,000 Common Share Purchase Warrants at $1.50 per share, resulting in the issuance of 3,240,000 common shares; - 167,275 IPO Warrants at $3.00 per share, resulting in the issuance of 167,275 common shares; - The exercise of 350,000 Broker Compensation Warrants at $0.30 per Broker Compensation Warrant resulted in the issuance of 350,000 common shares and the issuance of 350,000 additional Common Share Purchase Warrants, which were all exercised to acquire an additional 350,000 common shares at $0.40 per common share; and - The exercise of 340,000 Broker Compensation Warrants at $1.00 per Broker Compensation Warrant resulted in the issuance of 340,000 common shares and the issuance of 170,000 additional Common Share Purchase Warrants, which were all exercised, together with 75,000 Common Share Purchase Warrants in 2005 upon the exercise then of 150,000 Broker Compensation Warrants, to acquire an additional 245,000 common shares at $1.50 per common share. As at December 31, 2006, the following Common Share Purchase Warrants were outstanding: (i) 5,929,672 IPO Warrants exercisable to acquire a total of 5,929,672 common shares at $3.00 per share anytime before May 8, 2007; and (ii) 265,000 Common Share Purchase Warrants exercisable to acquire a total of 265,000 common shares at $0.40 per share until October 17, 2008. (e) Stock Options As at December 31, the company had stock options outstanding to acquire common shares, as follows: ------------------------------------------------------------------------- 2006 2005 ------------------------------------------------------------------------- Weighted Weighted Average Average Number Exercise Number Exercise of Shares Price of Shares Price ------------------------------------------------------------------------- Outstanding, beginning of year 2,437,000 $1.04 - $- Granted 991,000 12.17 2,437,000 1.04 Exercised (531,333) 0.97 - - ------------------------------------------------------------------------- Outstanding, end of year 2,896,667 $4.86 2,437,000 $1.04 ------------------------------------------------------------------------- Exercisable, end of year 1,057,666 $3.84 519,000 $1.30 ------------------------------------------------------------------------- All options have been granted for a period of five years. Options granted under the plan are generally fully exercisable after three years and expire five years after the date granted. The table below summarizes unexercised stock options. ------------------------------------------------------------------------- Weighted Average Number Remaining Contractual Range of Exercise Prices Outstanding Life at December 31, 2006 ------------------------------------------------------------------------- $0.50 - $2.00 1,906,667 3.5 $8.55 - $20.95 990,000 4.3 ------------------------------------------------------------------------- Total 2,896,667 ------------------------------------------------------------------------- Vested at December 31, 2006 1,057,666 ------------------------------------------------------------------------- In 2006 a compensatory non-cash expense of $3,628,000 (2005 - $124,000) was recorded, reflecting the fair value of stock options amortized over the vesting period. The fair value of each option granted in 2006 is estimated on the date of grant using the Black-Scholes option-pricing model with assumptions for grants as follows: ------------------------------------------------------------------------- Risk free interest Expected Expected rate life Volatility ------------------------------------------------------------------------- 2006 4.1% 3 years 43% - 66% 2005 3% 4 years 72% ------------------------------------------------------------------------- The weighted average fair value at the date of grant of all options granted in 2006 was $4.88 per option (2005 - $0.33 per option). (f) Elimination of deficit On October 4, 2005 the company's shareholders approved a reduction to the stated capital account attributable to the common shares of the company of $1,254,381. 9. RELATED PARTY TRANSACTIONS Under the terms of a Management Services Agreement with Connacher Oil and Gas Limited ("Connacher"), which expires in May 2007, Connacher provides all management, operational, accounting and general and administrative services necessary or appropriate to manage and administer the company. The fee for this service is $15,000 per month. From time to time Connacher also pays bills on behalf of Petrolifera, for which it is reimbursed. At December 31, 2006, the company owed Connacher $32,000 pursuant to the Management Services Agreement, and for other amounts advanced (2005 - $221,000). In 2006 the company paid professional legal fees in the amount of $613,000 (2005 - $509,000) to a law firm in which an officer of the company is a related party. Transactions with the related party occurred within the normal course of business and have been measured at the exchange amount on normal business terms. The exchange amount is the amount of consideration established and agreed to with the related parties. In consideration for the assistance provided to Petrolifera in securing two crude oil and natural gas exploration licenses in Peru and for the provision of financial guarantees respecting Petrolifera's annual work commitments in the licensed blocks in 2005, Connacher was granted an option to acquire 200,000 common shares at $0.50 per share and was granted a 10 percent carried working interest ("CWI") through the drilling of the first well on each block. Petrolifera has the right of first purchase of this interest should Connacher elect to sell it at some future date. The CWI is convertible at the holder's election into a two percent gross overriding royalty on each license after the drilling of the first well on each license. These interests were effective upon the issuance of the licenses in 2005. The guarantees are limited to amounts specified over the terms of the licenses and during the first 24 months, the guarantee is limited to US $200,000. Connacher was subsequently indemnified by Petrolifera for this guarantee. In consideration for his expertise and role in assisting the company in securing the two exploration licenses in Peru, an officer of the company received vested options to purchase 300,000 Common Shares at a price of $0.50 per share, exercisable until February 1, 2010, a single payment of $100,000 and pursuant to an overriding royalty agreement with the company, was granted a three percent gross overriding royalty ("GORR") on each of the two Peruvian blocks. The company recorded the $100,000 payment as a capital expenditure. The GORR vests over three years with one-third vesting immediately upon the issuance of the licenses in 2005, one-third vested in 2006 and the remaining one-third will vest in 2007. The company has the right of first purchase of the GORR at fair value should the officer elect to sell it at some future date. In consideration for his expertise and role in assisting the company in securing the two licenses in Peru, another officer of the company received vested options to purchase 300,000 Common Shares at a price of $0.50 per share, exercisable until February 1, 2010, and a success fee of $20,000 upon the closing of the March 2005 private placement financing and a success fee of $40,000 in November 2005, when the company completed its IPO financing. To assist in marketing the March 2005 private placement financing, the company retained PowerOne Capital Markets Limited ("PowerOne") as one of the selling agents. Prior to the March 2005 private placement financing, PowerOne was considered a connected issuer of Petrolifera because, together with its officers, directors and shareholders and associates of such persons, it then owned 18 percent of the outstanding shares of the company. PowerOne received a commission for its services. In March 2005 a Consulting Agreement with PowerOne was extended to November 2006 with a monthly fee of $6,000. An additional success fee ("PowerOne Success Fee") in the amount of $327,000 was paid to PowerOne upon the company completing its IPO financing in November 2005. 10. SEGMENTED INFORMATION The Company has corporate offices in Canada and Barbados (combined to comprise the corporate segment), petroleum and natural gas operations in Argentina and exploration activities in Peru. Financial information pertaining to these operating segments is presented below. ------------------------------------------------------------------------- Corporate Argentina Peru Total ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- 2006 Revenue, gross $826 $104,757 $- $105,583 Net earnings (loss) (6,262) 46,316 (160) 39,894 Property and equipment 268 35,027 2,520 37,815 Capital expenditures 268 34,333 1,799 36,400 Total assets 29,118 86,486 2,913 118,517 ------------------------------------------------------------------------- 2005 Revenue, gross $114 $2,750 $- $2,864 Net earnings (loss) (361) 8 (62) (415) Property and equipment 7,941 759 8,700 Capital expenditures 5,883 779 6,662 Total assets 20,442 10,199 940 31,581 ------------------------------------------------------------------------- Crude oil sales totaling $104 million were made to two large international oil companies during 2006 (2005 - $2.3 million to one large international oil company). 11. SUPPLEMENTARY INFORMATION (a) Per share amounts The following table summarizes the common shares used in the per share calculations. ------------------------------------------------------------------------- For the years ended December 31 2006 2005 ------------------------------------------------------------------------- Weighted average common shares outstanding 39,132,413 20,721,430 Dilutive effect of all stock options and all stock purchase warrants 10,823,848 11,081,933 ------------------------------------------------------------------------- Weighted average common shares outstanding - diluted 49,956,261 31,803,362 ------------------------------------------------------------------------- (b) Net change in non-cash working capital ------------------------------------------------------------------------- For the years ended December 31 2006 2005 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Accounts receivable $(24,808) $(1,861) Prepaid expenses (166) (105) Accounts payable 10,234 3,773 Crude oil inventory (374) - Income taxes payable 21,416 - Due to a related company (189) 114 ------------------------------------------------------------------------- Total $6,113 $1,921 ------------------------------------------------------------------------- Operating $1,317 $(704) Investing 4,796 2,625 ------------------------------------------------------------------------- $6,113 $1,921 ------------------------------------------------------------------------- (c) Supplementary cash flow information ------------------------------------------------------------------------- For the years ended December 31 2006 2005 ------------------------------------------------------------------------- ($000) ------------------------------------------------------------------------- Interest paid $- $92 Income taxes paid 552 - ------------------------------------------------------------------------- 12. COMMITMENTS, CONTINGENCIES AND GUARANTEES In 2005 Petrolifera acquired two significant oil and gas exploration licenses in Peru. The licenses have a total US$41.8 million financial commitment to complete negotiated work programs on the two licenses over seven years. The company has the right to withdraw from the licenses at the end of each interim period associated with the term of the licenses. The company has issued letters of credit in the amount of US$200,000 to secure the capital expenditure requirements associated with the two exploration licenses. The company's annual commitments under drilling contracts, management, consulting and operating agreements are as follows: 2007 - $12,505,000; 2008 - $7,813,000; 2009 - $3,890,000; 2010 - Nil; 2011 - Nil Additionally, the company has various guarantees and indemnifications in place in the ordinary course of business, none of which are expected to have a significant impact on the company's financial statements or operations. 13. RECLASSIFICATION OF COMPARATIVE BALANCES Certain comparative balances have been reclassified to conform with the current year's presentation

For further information:

For further information: Richard A Gusella, Executive Chairman,
Petrolifera Petroleum Limited, Phone: (403) 538-6202, Fax: (403) 538-6225,
inquiries@petrolifera.ca, www.petrolifera.ca

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PETROLIFERA PETROLEUM LIMITED

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