Rally Energy reports record production, revenue, cash flow and income in 2006



    "RAL" - TSX Exchange
    "RLE" - Frankfurt Stock Exchange
    www.rallyenergy.com

    CALGARY, March 20 /CNW/ - Rally Energy Corp. (the "Corporation") is
pleased to announce record operational and financial results for year-end
2006.

    
    HIGHLIGHTS:

                                               2006      2005   Change
                                           ----------------------------
        Production (BOE/D)
          Exit rate                           6,350     2,970     114%
          Average                             4,601     2,579      78%
        Average Price ($/BOE)                 44.54     37.07      20%
        Revenue ($ million)                    74.8      34.9     114%
        Cash Flow ($ million)                  31.2      11.9     162%
        Net Income ($ million)                  6.1(*)    1.5     307%
          (*)after Canadian oil and gas asset write-down of $10.5 million

        Reserves (MBOE)
          Proved                             44,588    18,644     139%
          Proved & Probable                 104,386    45,665     129%
    


    The Corporation's 2006 capital program of $70.1 million included the
drilling of 34 wells, construction of production facilities in Egypt and
Pakistan and the acquisition of an additional interest in the Safed Koh
concession in Pakistan.
    In Egypt, 28 conventional and thermal wells were originally planned for
2006, but 31 wells were actually drilled, resulting in 31 oil wells. In
Canada, three wells were drilled resulting in three oil/gas wells (.82 wells
net). In Egypt, a 5,000 BOPD central production facility and a 50 million BTU
steam generating plant are in the final stages of construction. Commissioning
is scheduled to begin in a few weeks. In Pakistan, an 18 km gas pipeline and a
60 MMCF/D gas plant have been completed; the first 30 MMCF/D gas plant train
is expected to commence operations later this month and the second train will
be completed by June of this year.
    Successful drilling combined with successful Cyclic Steam Stimulation
performance results at the Issaran field in Egypt and increased ownership in
Pakistan resulted in a 129% increase in recognized year-end 2006 proved and
probable oil and gas reserves to 104 million BOE.
    Other highlights of 2006 include a proved and probable finding and
development cost, including facility costs of $4.80/BOE (proved - $6.04/BOE),
achievement of a proved reserves replacement ratio of 16 times and operating
costs averaging $7.88/BOE.
    The Corporation ended the year with $23.3 million long term debt,
$6.5 million of capital inventory and $3.3 working capital, of which
$18.9 million was cash.


    
                     ----------------------------------
    

    Based in Calgary, Alberta, Canada, Rally Energy is an oil and gas
exploration, development and production company. The Corporation's primary
area of operations is in Egypt, where it has a 100% operating interest in the
Issaran Oilfield, a significant heavy oil development opportunity with strong
growth potential. In Pakistan, the Corporation holds a 30% interest in the
Safed Koh Block, where it is participating in the development of a large
natural gas/condensate discovery.

    
                     ----------------------------------

                         FORWARD-LOOKING STATEMENTS
    

    Except for statements of historical fact, all statements in this news
    release - including, without limitation, statements regarding production
    estimates, potential reserves and future plans and objectives of Rally -
    are forward-looking statements that involve various risks and
    uncertainties. There can be no assurance that such statements will
    prove to be accurate; actual results and future events could differ
    materially from those anticipated in such statements. Important factors
    that could cause actual results to differ materially from anticipated
    results include risks and uncertainties most of which are beyond Rally's
    control such as: risks relating to estimates of reserves and recoveries;
    production rates and operating cost assumptions; development risks and
    costs; the risk of commodity price and currency fluctuations; general
    economic and industry conditions; political and regulatory risks;
    environmental risks; stock market volatility; access to sufficient
    capital from internal and external sources; and other risks and
    uncertainties as disclosed under the heading "Risk Factors" and
    elsewhere in Rally's documents filed from time-to-time with the Toronto
    Stock Exchange and other regulatory authorities. The reader is
    cautioned that assumptions used in the preparation of such information,
    while considered reasonable by Rally at the time, may prove to be
    incorrect. The Corporation disclaims any intention or obligation to
    update or revise any forward-looking statements, whether as a result of
    new information, future events or otherwise.

    The TSX has neither approved nor disapproved of the contents of this news
    release.


    
                             RALLY ENERGY CORP.
                Management's Discussion and Analysis ("MD&A")
                     For the Year Ended December 31, 2006
    

    This discussion and analysis outlines management's assessment of the
consolidated financial and operating results of Rally Energy Corp. ("Rally
Energy" or the "Corporation") and its subsidiaries, including its future
opportunities and risks, and should be read in conjunction with the audited
financial statements and related notes for the year ended December 31, 2006.
Additional information regarding the Corporation can be found at www.sedar.com
and www.rallyenergy.com.
    The financial information contained herein has been prepared by
management of Rally Energy in accordance with Canadian Generally Accepted
Accounting Principles ("GAAP"). Unless otherwise indicated, all dollar amounts
in this MD&A are in thousands of Canadian dollars. The majority of the
Corporation's production is heavy oil (reported in barrels), however, the
Corporation also uses the "barrels of oil equivalent" (boe) reference in this
report to reflect Canadian natural gas sales. All boe conversions are derived
by converting gas to oil in the ratio of six thousand cubic feet of gas to one
barrel of oil, representing the approximate energy equivalency. This MD&A is
dated March 20, 2007.

    Non-GAAP Measures

    Certain measures in this MD&A do not have any standardized meaning as
prescribed by Canadian GAAP such as cash flow, cash flow per share - basic,
cash flow from operations, and netback from operations. Therefore, they are
considered non-GAAP measures and may not be comparable to similar information
presented by other issuers. These measures have been described and presented
in order to provide shareholders and potential investors with additional
information regarding the Corporation's liquidity and its ability to generate
funds to finance its operations. Management's use of these measures has been
disclosed further in this MD&A as they are discussed and presented.

    Forward-Looking Statements

    Except for statements of historical fact, all statements in this news
release - including, without limitation, statements regarding production
estimates, potential reserves and future plans and objectives of the
Corporation are forward-looking statements that involve various risks and
uncertainties. There can be no assurance that such statements will prove to be
accurate; actual results and future events could differ materially from those
anticipated in such statements. Important factors that could cause actual
results to differ materially from anticipated results include risks and
uncertainties most of which are beyond the Corporation's control such as:
risks relating to estimates of reserves and recoveries; production rates and
operating cost assumptions; development risks and costs; the risk of commodity
price and currency fluctuations; general economic and industry conditions;
political and regulatory risks; environmental risks; stock market volatility;
access to sufficient capital from internal and external sources; and other
risks and uncertainties as disclosed under the heading "Business Risks and
Uncertainties" and elsewhere in the Corporation's documents filed from
time-to-time with the Toronto Stock Exchange and other regulatory authorities.
The reader is cautioned that assumptions used in the preparation of such
information, while considered reasonable by the Corporation at the time, may
prove to be incorrect. The Corporation disclaims any intention or obligation
to update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.

    Vision, Core Business and Strategy

    Rally Energy is a Calgary-based oil and gas exploration, development and
production company with production, development and exploration activities in
Egypt and Canada and exploration activities in Pakistan. The Corporation's
international strategy is to enhance value by applying Canadian exploration/
development techniques and technology to the production of reserves.
    The Issaran oilfield in Egypt, accounts for substantially all of the
Corporation's revenues and has a large prospective inventory of additional
well locations. A wholly-owned subsidiary of the Corporation entered into a
Petroleum Service Agreement ("PSA") with The General Petroleum Co., S.A.E.
("GPC"), effective November 4, 1998, pursuant to which the Corporation was
granted the exclusive right to develop and produce heavy oil from a 72 square
kilometre portion of the Ras Issaran concession area located on the west shore
of the Gulf of Suez. On October 18, 2001, the Corporation entered the
Commercial Development Period of the PSA, after having successfully satisfied
the terms of the three-year Piloting Period. The Corporation has the option to
extend the 20-year term of the PSA (commencing from November 4, 1998), for up
to two additional five-year terms subject to the concurrence of GPC. The
Commercial Development Period does not require any specific capital
expenditure commitments. Details of the PSA are disclosed in Note 12(a) of the
consolidated financial statements and in the Production Entitlements,
Marketing Costs and Royalties section below. Rally Energy has established
field and administration offices in Egypt, staffed by Egyptian nationals, to
manage and operate the Issaran oilfield. Calgary-based technical personnel,
along with expatriate personnel, provide management and technical expertise to
support planning, drilling and general operating activities. Additionally, the
Corporation recognizes the importance of maintaining strong relationships with
Egyptian authorities to resolve any operational or business issues as they may
arise.
    In Pakistan, Rally Energy, through a wholly-owned subsidiary, is party to
a Concession Agreement, covering the 200,000 acre Safed Koh Block, with the
Pakistan Government. During 2006, Rally Energy established an administration
office in Islamabad, staffed by Pakistani nationals, to more effectively
liaise with the operator of the concession. With completion of the acquisition
of an additional 7.5% working interest, the Corporation holds a 30% working
interest. Drilling activity in 2005 led to a Declaration of Commerciality in
January 2006. Upon commencement of natural gas production, additional drilling
will be carried out under Phase II of the exploration program.

    
    OVERALL 2006 PERFORMANCE

    Egypt:

      -  production increased to 4,474 bbls/d.
      -  significant oil reserves increases.
      -  drilling of 31 successful Issaran oil wells.
      -  significant progress in construction of production and steam
         facilities.

    Pakistan:

      -  received Commerciality Declaration for Salsabil field in
         January 2006.
      -  commenced building gas plant and related facilities for
         production commencement in 2007.
      -  acquired an additional 7.5% interest, increasing ownership to 30%.

    Canada:

      -  sold the majority of Canadian reserve base and production for
         $6.9 million.
      -  drilled three (0.8 net) successful oil and gas wells; satisfied
         flow-through share requirements.

    Debt/Equity:

      -  $14.5 million of new equity from warrants, options and
         converted debentures.
      -  Established a long-term $23 (US$20) million credit facility.


    ANNUAL COMPARATIVE SUMMARY
                                                  2006       2005      2004
    -------------------------------------------------------------------------
                              (thousands of dollars, unless otherwise stated)
    -------------------------------------------------------------------------

    Production (boe/d)                           4,601      2,579      1,978
    Revenue                                    $74,794    $34,899    $22,392

    Cash flow from operations                  $31,246    $11,883     $8,283
      Per share - basic                          $0.33      $0.15      $0.12

    Income                                      $6,108(*)  $1,541     $1,238
      Per share - basic                          $0.07      $0.02      $0.02

    Total assets                              $135,080    $59,698    $43,116
    Convertible debentures                           -     $1,314     $6,000
    Long-term debt                             $23,308          -          -
    Working capital                             $3,345       $699      $(345)
    -------------------------------------------------------------------------
    (*) After 10.5 million write-down of Canadian oil and gas assets.

             No dividends have been declared by the Corporation.
    



    In 2006, revenues increased by 114%, primarily as a result of increased
oil sales from the Issaran oilfield in Egypt and higher world oil prices. The
Corporation acquired its producing interests in Egypt through the acquisition
of Scimitar Hydrocarbons Corporation in mid-2002 and has consistently
increased sales through a successful and ongoing drilling program. Revenues
from Canadian properties decreased to $2.4 million in 2006 (2005 -
$3.0 million). Revenues in 2007 will increase further as a result of ongoing
drilling in Egypt and commencement of gas production from the Salsabil,
Pakistan natural gas field.

    Cash Flow from Operations

    Cash flow represents funds from operations as detailed on the
consolidated statements of cash flows. For the year ended December 31, 2006,
Rally Energy's cash flow from operations increased to $31.2 million
($0.33/share) from $11.9 million ($0.15/share) for the comparable 2005 period.
Cash flow from operations was $6.3 million ($0.06/share) in the fourth quarter
of 2006 as compared to $3.4 million ($0.05/share) in the comparable 2005
quarter. Cash flow from operations was lower for the 2006 fourth quarter, as
compared to the 2006 third quarter, primarily as a result of an average 19%
commodity price reduction in conjunction with a 7% production decline, higher
activity-related operating expenses and year-end compensation adjustments.
During the fourth quarter, the Corporation had anticipated its Egyptian oil
production would be slightly lower since the drilling program was concentrated
on thermal wells which require a 50 day steam injection cycle prior to
production, as compared to conventional wells which are usually on-stream
within 10 days of drilling commencement.
    Cash flow from operations ("Cash Flow"), representing cash generated from
operating activities before changes in non-cash working capital items, is a
non-GAAP measure. Management utilizes Cash Flow as a key measure to assess the
ability of the Corporation to finance operating activities and capital
expenditures. Additionally, Cash Flow has been described and presented in
order to provide shareholders and potential investors with information
regarding the Corporation's liquidity and its ability to generate funds to
finance its operations. This performance indicator may not be comparable to
similar measures used by other companies.

    Net Income

    Net income for 2006 was $6.1 million ($0.07/share), a 296% increase from
net income of $1.5 million ($0.02/share) for 2005. The 2006 net income was
negatively affected by a $10.5 million write-down of Canadian oil and gas
assets. For the 2006 fourth quarter, reported income was $1.5 million
($0.02/share). For the fourth quarter of 2005, Rally Energy reported net
income of $0.6 million ($0.01/share).

    
    SUMMARY OF QUARTERLY RESULTS

    (thousands of dollars, unless otherwise stated)

                                  Cash flow
                                       from   $/share     Income     $/share
                       Revenue   operations   - basic      (loss)    - basic
                       -------   ----------   -------      ------    -------

    2006
      Q1              $ 10,061     $  3,445     $0.04   $    866     $ 0.010
      Q2                19,605        8,362     $0.09      4,213      $0.046
      Q3                25,708       13,092     $0.14       (505)    $(0.005)
      Q4                19,420        6,347     $0.06      1,534      $0.016
                      ---------    ---------            ---------
    Year              $ 74,794     $ 31,246             $  6,108
                      ---------    ---------            ---------
                      ---------    ---------            ---------

    2005
      Q1              $  5,369     $    856     $0.01   $   (895)    $(0.010)
      Q2                 8,813        3,235     $0.04        484      $0.005
      Q3                10,698        4,387     $0.05      1,334      $0.016
      Q4                10,019        3,405     $0.05        618      $0.007
                      ---------    ---------            ---------
    Year               $34,899      $11,883             $  1,541
                      ---------    ---------            ---------
                      ---------    ---------            ---------

    2004
      Q1              $  4,459     $  1,724     $0.02   $   (559)     $(0.01)
      Q2                 5,400        2,202     $0.03        (28)     $(0.00)
      Q3                 6,743        3,187     $0.05        687       $0.01
      Q4                 5,790        1,170     $0.02      1,138       $0.02
                      ---------    ---------            ---------
    Year               $22,392     $  8,283             $  1,238
                      ---------    ---------            ---------
                      ---------    ---------            ---------


    Quarterly revenues fluctuate with sales volumes and market-driven
commodity prices. Quarterly income (loss) is also impacted by fluctuations in
depletion charges based on estimated quarterly reserves additions,
supplemented by an independent reserves report update at year-end.

    Sales, Revenue and Netback

    (thousands of dollars, unless otherwise stated)

                                              2006
                -------------------------------------------------------------
                    First Quarter        Second Quarter       Third Quarter
                    -------------        --------------       -------------

    Production:
      Oil (bbls/d)     2,676                4,509                5,658
      Natural gas
      (mcf/d)            388                  396                  348
      Total BOE
      (boe/d)          2,741                4,575                5,716

                             $/boe                $/boe                $/boe
                             -----                -----                -----
    Gross
     revenue    $ 10,061   $ 40.79   $ 19,605   $ 47.09   $ 25,708   $ 48.89
    Production
     entitlement
     - GPC
     (Egypt)      (2,695)   (10.93)    (5,585)   (13.41)    (7,397)   (14.08)
    Overriding
     Royalty
     (Egypt)        (611)    (2.48)    (1,061)    (2.55)         -         -
    Marketing
     fees           (171)    (0.69)      (213)    (0.51)      (257)    (0.49)
    Royalties
     (Canada)       (142)    (0.57)      (105)    (0.25)      (108)    (0.21)
    Operating
     expenses     (2,122)    (8.60)    (2,898)    (6.96)    (3,601)    (6.85)
                -------------------------------------------------------------
    Netback from
     Operations $  4,320   $ 17.52   $  9,743   $ 23.41   $ 14,345   $ 27.26
                -------------------------------------------------------------
                -------------------------------------------------------------

                                  2006
                ---------------------------------------
                    Fourth Quarter          Year
                    --------------          ----

    Production:
      Oil (bbls/d)     5,289               4,543
      Natural gas
       (mcf/d)           258                 348
      Total BOE
       (boe/d)         5,332               4,601

                             $/boe               $/boe
                             -----               -----
    Gross
     revenue    $ 19,419   $ 39.58  $ 74,794   $ 44.54
    Production
     entitlement
     - GPC
     (Egypt)      (5,692)   (11.61)  (21,369)   (12.72)
    Overriding
     Royalty
     (Egypt)           -         -    (1,672)    (1.00)
    Marketing
     fees           (246)    (0.50)     (888)    (0.53)
    Royalties
     (Canada)        (35)    (0.07)     (390)    (0.23)
    Operating
     expenses     (4,612)    (9.40)  (13,233)    (7.88)
                ---------------------------------------
    Netback from
     Operations $  8,834   $ 18.00  $ 37,242   $ 22.18
                ---------------------------------------
                ---------------------------------------



                                               2005
                -------------------------------------------------------------
                    First Quarter        Second Quarter       Third Quarter
                    -------------        --------------       -------------

    Production:
      Oil (bbls/d)     2,177                2,734                2,558
      Natural gas
       (mcf/d)            84                  240                  330
      Total BOE
       (boe/d)         2,191                2,774                2,613

                             $/boe                $/boe                $/boe
                             -----                -----                -----
    Gross
     revenue    $  5,369   $ 27.23   $  8,813   $ 34.91   $ 10,698   $ 44.51
    Production
     entitlement
     - GPC
     (Egypt)      (1,565)    (7.94)    (2,380)    (9.43)    (2,898)   (12.07)
    Overriding
     Royalty
     (Egypt)        (347)    (1.76)      (558)    (2.21)      (629)    (2.62)
    Marketing
     fees           (174)    (0.88)      (186)    (0.74)      (103)    (0.43)
    Royalties
     (Canada)         (5)    (0.03)        (5)    (0.01)      (104)    (0.43)
    Operating
     expenses     (1,404)    (7.12)    (1,545)    (6.12)    (1,672)    (6.96)
                -------------------------------------------------------------
    Netback from
     Operations $  1,874   $  9.50   $  4,139   $ 16.40   $  5,292   $ 22.00
                -------------------------------------------------------------
                -------------------------------------------------------------

                                  2005
                ---------------------------------------
                    Fourth Quarter          Year
                    --------------          ----

    Production:
      Oil (bbls/d)     2,656               2,533
      Natural gas
       (mcf/d)           462                 276
      Total BOE
       (boe/d)         2,733               2,579

                             $/boe               $/boe
                             -----              -----
    Gross
     revenue    $ 10,019   $ 39.85  $ 34,899   $ 37.07
    Production
     entitlement
     - GPC
     (Egypt)      (2,631)   (10.47)   (9,474)   (10.06)
    Overriding
     Royalty
     (Egypt)        (255)    (1.02)   (1,789)    (1.90)
    Marketing
     fees           (159)    (0.63)     (622)    (0.66)
    Royalties
     (Canada)       (143)    (0.57)     (257)    (0.27)
    Operating
     expenses     (2,098)    (8.35)   (6,719)    (7.14)
                ---------------------------------------
    Netback from
     Operations $  4,733   $ 18.81  $ 16,038   $ 17.04
                ---------------------------------------
                ---------------------------------------


                                             2004
                -------------------------------------------------------------
                    First Quarter        Second Quarter       Third Quarter
                    -------------        --------------       -------------

    Production:
      Oil (bbls/d)     1,735                1,794                2,092
      Natural gas
       (mcf/d)            24                  210                   60
      Total BOE
       (boe/d)         1,739                1,829                2,102

                             $/boe                $/boe                $/boe
                             -----                -----                -----
    Gross
     revenue    $  4,459   $ 28.18   $  5,400   $ 32.45   $  6,743   $ 34.87
    Production
     entitlement
     - GPC
     (Egypt)        (862)    (5.45)    (1,027)    (6.18)    (1,272)    (6.58)
    Marketing
     fees           (100)    (0.63)      (141)    (0.85)      (124)    (0.64)
    Royalties
     (Canada)         (6)    (0.04)       (21)    (0.12)       (12)    (0.06)
    Operating
     expenses       (858)    (5.43)    (1,026)    (6.16)      (961)    (4.97)
                -------------------------------------------------------------
    Netback from
     Operations $  2,633   $ 16.63   $  3,185   $ 19.14   $  4,374   $ 22.62
                -------------------------------------------------------------
                -------------------------------------------------------------

                                   2004
                --------------------------------------
                  Fourth Quarter           Year
                  --------------           ----

    Production:
      Oil (bbls/d)     2,206               1,961
      Natural gas
       (mcf/d)           192                 102
      Total BOE
       (boe/d)         2,238               1,978

                             $/boe              $/boe
                             -----              -----
    Gross
     revenue    $  5,790   $ 28.12  $ 22,392  $ 30.93
    Production
     entitlement
     - GPC
     (Egypt)      (1,978)    (9.62)   (5,139)   (7.09)
    Marketing
     fees           (161)    (0.78)     (526)   (0.73)
    Royalties
     (Canada)        (25)    (0.12)      (64)   (0.09)
    Operating
     expenses     (1,296)    (6.29)   (4,141)   (5.72)
                --------------------------------------
    Netback from
     Operations $  2,330   $ 11.31  $ 12,522  $ 17.30
                --------------------------------------
                --------------------------------------
    

    Average production for 2006 was 4,601 boe/d, up 78% from 2,579 boe/d
during 2005. Gross revenue for 2006 increased to $74.8 million ($44.54/boe),
before royalties and related credits, as compared to $34.9 million
($37.07/boe) for 2005. The revenue increase is attributable to additional
sales from the Issaran oilfield in Egypt, supplemented by Canadian oil and
natural gas sales, along with higher commodity prices. Production optimization
from new pump installations and well workovers, coupled with new production
from the Corporation's ongoing drilling program, have resulted in consistently
higher production levels and additional reserves, resulting in a proved
reserves replacement ratio of 16 times for 2006. Fourth quarter 2006
production averaged 5,332 boe/d with reported revenue of $19.4 million
($39.58/boe), a 95% increase from 2,733 boe/d and revenue of $10.0 million
($39.85/boe), for the fourth quarter of 2005.
    Netback from operations represents gross revenue after satisfying all
royalty burdens (including GPC's production entitlement), marketing fees and
operating costs. For 2006, Rally Energy's netback was $37.2 million
($22.18/boe), a significant increase from the 2005 netback of $16.0 million
($17.04/boe). The netback for the fourth quarter of 2006 was $8.8 million
($18.00/boe), as compared to $4.7 million ($18.81/boe) for the corresponding
2005 fourth quarter.
    Heavy oil produced from the Issaran oilfield is marketed as Ras Gharib
blend. For 2006, the Corporation's realized wellhead oil price averaged 60% of
the Brent oil price as compared to 54% for 2005. The realized wellhead oil
price fluctuated between 55% and 63% during 2006.

    Production Entitlements, Marketing Costs and Royalties

    Under the terms of the Issaran oilfield PSA, as amended, GPC is entitled
to certain varying amounts of Issaran oilfield production. For 2006, GPC's
share of production from wells drilled subsequent to the PSA commencement
("new wells") is 28% and 55% of production from the nine wells that existed
prior to the PSA, for an average of 29%. During 2005, GPC's total share was
27%. This payment satisfies the Corporation's entire tax liability for Issaran
oil production in Egypt. The sharing ratio for new wells changes relative to
oil production level, as shown below:

    
                          Rally's Share of Production
    -----------------   ---------------------------------
      Oil Production
       Level (bbls/d)    Incremental          Cumulative
    -----------------   -------------   -----------------
         Up to 3,146        73.0%                 73%
      3,147 to 6,292        70.5%                 71%
      6,293 to 9,438        64.0%                 69%
     9,439 to 12,584        62.0%                 67%
    12,585 to 18,876        52.0%                 62%
    18,877 to 25,168        43.0%                 57%
         Over 25,169        33.5%                 53%
    

    For the year ended December 31, 2006, GPC payments totalled $21.4 million
($12.72/boe), representing 29% of gross revenue. For the corresponding 2005
period, GPC payments were $9.4 million ($10.06/boe), representing 27% of gross
revenue. For the fourth quarter of 2006, GPC's entitlement increased to
$5.7 million (29%) from $2.6 million (26%) for the comparable 2005 quarter.
    The Corporation is required to make revenue-based overriding royalty
payments from the Issaran Oilfield to Gemini Oil and Gas Limited, an
independent oil and gas investment fund. The revenue-based royalty of 10%, to
a maximum of US$1.5 million in each of 2005 and 2006, is reduced to 2.6% of
Issaran oil revenues (net of marketing fees and GPC entitlements), from a
maximum of 7,000 bbls/d of production, commencing January 1, 2007 and
continuing until December 31, 2012. Royalty payments for 2006 were
$1.7 million ($1.00/boe), representing 2% of gross revenue (2005 -
$1.8 million) ($1.90/boe).
    Pursuant to the terms of certain marketing agreements pertaining to
Issaran oil sales, marketing fees, linked to realized oil prices and
production, of $888,000 ($0.53/boe) were paid during 2006 as compared to
$622,000 ($0.66/boe) for 2005. Marketing fees paid for the fourth quarter
ended December 31, 2006 were $246,000 ($0.50/boe) and $159,000 ($0.63/boe) for
the comparable 2005 period. Marketing fees are included in royalties and
related credits on the consolidated statements of income and deficit.
Obligations under one marketing agreement were fully satisfied on February 28,
2006 which has resulted in lower per-unit marketing costs for the balance of
2006.
    Royalty obligations on Canadian production for 2006 and 2005 were
$390,000 ($0.23/boe) and $257,000 ($0.27/boe), respectively. During 2005,
production from a primary producing property benefited from a one-year oil
royalty holiday which expired in January 2006.

    Operating Expenses

    Operating expenses for 2006 were $13.2 million ($7.88/boe) as compared to
$6.7 million ($7.14/boe) for 2005. Operating expenses were $4.6 million
($9.40/boe) in the fourth quarter of 2006 compared to $2.1 million ($8.35/boe)
for the same period in 2005. On an overall basis, costs have increased
commensurate with the higher oil production in 2006. Approximately 73% of
operating expenses in 2006 represent variable costs as compared to 69% in
2005. Primary contributors to higher operating expenses are related to health,
safety and environmental ("HSE"), diesel fuel costs, and increased trucking
costs. Additionally, well workover activity increased during the fourth
quarter of 2006. In Egypt, the Corporation enhanced its HSE program resulting
in higher expenditures during the last quarter, a portion of which is
non-recurring; on an annual basis, HSE costs will be lower overall and more
evenly distributed. Diesel fuel is used to power generators to provide
electricity for field operations in our Issaran oilfield and, in the second
quarter of 2007, Rally Energy will commence utilization of lower cost natural
gas from nearby sources as an alternative to diesel fuel for generators.
Trucking rates for the Corporation's Issaran oil deliveries have increased due
to the increased fleet requirements associated with higher production. Also
included in the 2006 operating expense amount is $292,000 (2005 - $246,000) of
costs pertaining to Canadian production.
    For the year ended December 31, 2006, operating expenses represent 18% of
gross revenue as compared to 19% for the prior year. On a per-unit basis,
higher oil sales can reasonably be expected to be achieved with lower per-unit
costs since increased production can still be accommodated within our existing
fixed cost structure.

    
    General and Administrative Expenses

    (thousands of dollars, unless otherwise stated)

                         Total       Capitalized     Expensed        $/boe
                         -----       -----------     --------        -----
    2006
        Canada     $      6,424   $     (1,094)  $      5,330   $       3.17
         Egypt            1,702              -          1,702           1.01
      Pakistan              724           (485)           239           0.15
                   ----------------------------------------------------------
         Total     $      8,850   $     (1,579)  $      7,271   $       4.33
                   ----------------------------------------------------------
                   ----------------------------------------------------------
    2005
        Canada     $      4,077   $       (625)  $      3,452   $       3.67
         Egypt            1,517              -          1,517           1.61
      Pakistan              410           (313)            97           0.10
                  ----------------------------------------------------------
         Total     $      6,004   $       (938)  $      5,066   $       5.38
                   ----------------------------------------------------------
                   ----------------------------------------------------------
    2004
        Canada     $      2,954   $       (479)  $      2,475   $       3.42
         Egypt            1,077              -          1,077           1.49
      Pakistan              269            (15)           254           0.35
                   ----------------------------------------------------------
         Total     $      4,300   $       (494)  $      3,806   $       5.26
                   ----------------------------------------------------------
                   ----------------------------------------------------------
    

    Consolidated general and administrative ("G&A") expenses were
$7.3 million ($4.33/boe) for 2006 as compared to $5.1 million ($5.38/boe) for
2005, with the increase primarily attributable to higher labour costs
resulting from staff additions, options expensing and annual wage increases.
Non-cash expenses related to the valuation of share options granted during
2006 were $2.1 million as compared to $1.4 million for 2005. Additional share
options granted during 2006 and the higher valuation determination for the
options led to the increase. For the quarter ended December 31, 2006,
consolidated G&A expenses were $2.4 million ($4.92/boe) as compared to
$2.1 million ($8.23/boe) for the comparable 2005 quarter.
    Excluding the non-cash component, G&A costs for 2006 were $5.2 million
($3.08/boe) down 20% on a boe basis from $3.6 million ($3.86/boe) for the
comparable 2005 period.
    Rally Energy capitalizes those portions of G&A expenses that relate to
exploration projects in Pakistan and Canada. Currently, all G&A costs related
to Egypt are associated with development activities and, accordingly, to date
none have been capitalized. During 2006, $1.6 million (18%) of G&A costs were
capitalized as compared to $938,000 (16%) for 2005.
    General and administrative costs associated with our Pakistan activities
during 2006 totalled $0.7 million (2005 - $0.4 million) of which $0.2 million
(2005 - $0.1 million) has been expensed. These costs increased in 2006
commensurate with the higher activity level in Pakistan associated with
development of facilities and related infrastructure.

    
    Interest and Finance Charges

    (thousands of dollars, unless otherwise stated)

                                          2006           2005           2004
                                  -------------------------------------------
    Interest expense              $        871   $        629   $        828
    Accretion expense on
     debentures                             26            189            144
    Amortization of deferred charge        625             77            144
                                  -------------------------------------------
      Total expense                      1,522            895          1,116
                                  -------------------------------------------
    Interest income                        193             37             50
    Loss on foreign exchange              (484)           (24)          (129)
    Gain (loss) on asset disposition       (37)            92              5
                                  -------------------------------------------
      Total income (expense)              (328)           105            (74)
                                  -------------------------------------------
      Net expense                 $      1,850   $        790   $      1,190
                                  -------------------------------------------
                                  -------------------------------------------
        $/boe                     $       1.10   $       0.84   $       1.64
                                  -------------------------------------------
                                  -------------------------------------------
    

    Total interest and finance charges increased to $1.9 million during 2006
from $0.8 million in 2005 primarily as a result of interest paid under the
Corporation's credit facilities as described in Note 7 of the consolidated
financial statements. Additionally, amortization of deferred charges commenced
in mid-2006 with the establishment of the International Finance Corp. credit
facility. On a quarterly comparison basis, net interest and finance charges
were $962,000 for the fourth quarter of 2006, as compared to $45,000 for the
fourth quarter of 2005.
    Higher average borrowing levels under the Corporation's credit facilities
in 2006 resulted in higher interest expense which was partially offset by
lower interest expense associated with the Corporation's 12% unsecured
convertible debentures of which all but $7,000, which were paid out at
maturity, were converted into common shares at $1.10/share. Additional details
are disclosed in Note 6 of the consolidated financial statements. In the
normal course of business, the Corporation earns interest from invested funds
and records foreign exchange gains (losses) as applicable.

    
    Depletion, Depreciation and Accretion

    (thousands of dollars, unless otherwise stated)

                                          2006           2005           2004
                                 --------------------------------------------
    Depletion, depreciation
     and accretion               $      11,283   $      8,371   $      6,288
                                 --------------------------------------------
                                 --------------------------------------------
      $/boe                      $        6.72   $       8.89   $       8.69
                                 --------------------------------------------
                                 --------------------------------------------
    

    Total depletion, depreciation and accretion ("DD&A") charges for 2006
were $11.3 million ($6.72/boe), of which depletion pertaining to producing
properties in Egypt represented $8.0 million (2005 - $5.3 million). The
remainder represents depletion charges of $2.7 million for Canadian
production, fixed asset depreciation of $552,000 and $26,000 for accretion of
asset retirement obligations. No depletion was recorded for the Pakistan
assets as they are in the pre-production stage. DD&A charges for 2005 were
$8.4 million ($8.89/boe). On a quarterly comparison basis, 2006 fourth quarter
DD&A was $2.9 million ($5.84/boe) as compared to $2.2 million ($8.88/boe) for
the 2005 fourth quarter.
    The significant increase in our proved reserve base at December 31, 2006,
as evaluated by DeGolyer and MacNaughton Canada Limited, an independent
reservoir evaluation firm, coupled with the anticipated future capital
requirements has resulted in a lower consolidated DD&A rate for 2006 of
$6.72/boe (2005 - $8.89/boe).  DD&A also includes the depletion of the asset
retirement obligation included in property and equipment and accretion expense
related to the corresponding liability.

    Capital Invested

    In 2006, Rally Energy drilled 34 wells (31.8 net); 31 (31 net) at the
Issaran oilfield in Egypt, and 3 (0.8 net) in Canada. In Egypt, 24 were
conventional Nukhul wells and 7 were Upper Dolomite steam wells in stage one
of the Cyclic Steam Stimulation ("CSS") thermal expansion program. Capital
expenditures totalled $70.1 million during 2006 (before disposition proceeds
of $6.9 million from the Canadian properties), up from $22.7 million in 2005.

    
    (thousands of dollars)                2006           2005           2004
                                  -------------------------------------------
    Egypt
      Drill, complete and
       workovers                  $     23,966   $     13,284   $     11,397
      Facilities, equipment and
       other                             8,254          1,477            807
      Thermal project                    8,904              -              -
      Inventory change                   4,680          1,251           (616)
      Property acquisition
       (disposition)                         -              -         (3,923)
      Capitalized admin. costs               -              -              -
                                  -------------------------------------------
        Total                     $     45,804   $     16,012   $      7,665
                                  -------------------------------------------
    Canada
      Drill, complete and
       workovers                  $      3,035   $      3,652   $      2,992
      Facilities, equipment and
       other                               247            386            564
      Property acquisition
       (disposition)                    (6,938)           424           (170)
      Capitalized admin. costs           1,094            625            479
                                  -------------------------------------------
        Total                     $     (2,562)  $      5,087   $      3,865
                                  -------------------------------------------
    Pakistan
      Drill, complete and
       workovers                             -   $      1,221              -
      Facilities, equipment
       and other                  $      6,404   $         36   $         11
      Property acquisition
       (disposition)                    13,018              -              -
      Capitalized admin. costs             486            312             15
                                  -------------------------------------------
        Total                     $     19,908   $      1,569   $         26
                                  -------------------------------------------
    Grand Total
      Drill, complete and
       workovers                  $     27,001   $     18,157   $     14,389
      Facilities, equipment and
       other                            14,905          1,899          1,382
      Thermal project                    8,904              -              -
      Inventory change                   4,680          1,251           (616)
      Property acquisition
       (disposition)                     6,080            424         (4,093)
      Capitalized admin. costs           1,580            937            494
                                  -------------------------------------------
        Total                     $     63,150   $     22,668   $     11,556
                                  -------------------------------------------

    Write-down of assets
      Canada                      $    (10,529)             -              -
                                  -------------------------------------------
        Net Additions             $     52,621              -              -
                                  -------------------------------------------
                                  -------------------------------------------
    

    The 2006 drilling and workover activities in Egypt, coupled with
successful results from the CSS program, resulted in increased oil sales and
higher oil reserves. In Pakistan, the Corporation was focused on building
necessary facilities to bring natural gas production on-stream in early 2007.
Canadian activities were limited to existing non-core areas and satisfied all
remaining flow-through share renunciation requirements. Included in the above
amounts are casing, tubing and capital equipment inventory costs of
$6.5 million at December 31, 2006 (2005 - $1.8 million) to be used in future
Issaran drilling programs.
    On October 24, 2006, the Corporation announced it had signed an agreement
to increase its working interest in the Safed Koh Concession from 22.5% to
30%. The $13.0 (US$11.4) million Offer to Purchase the additional 7.5% working
interest was made to one of Rally Energy's existing Safed Koh Block partners
(a private company). On March 2, 2007, all requisite Pakistan government
approvals were received and the US$11.4 million purchase price was satisfied
by way of US$8.55 million in cash and 1,372,846 common shares of Rally Energy
Corp. The shares were reserved for issuance in June 2006 at the then
prevailing price of $2.30 per share.
    On December 15, 2006, the Corporation announced it had disposed of
certain Canadian oil and gas properties, effective December 1, 2006, to an
independent private company, for $6.9 million ($5.0 million in cash and
$1.9 million in common shares of the private company).
    At December 31, 2006, the Corporation continued to meet the asset
impairment test for capitalized costs related to oil and gas investments in
Egypt and Pakistan, and no ceiling test write-down was required. At
December 31, 2006, the Corporation recorded a write-down of $10.5 million
related to valuation impairments associated with the carrying value of the
Canadian petroleum and natural gas assets. The write-down primarily relates to
costs originally incurred between 2001 and 2004 resulting from the
Corporation's abandoned Prince Edward Island oil and gas exploration programs.

    Liquidity and Capital Resources

    At December 31, 2006, Rally Energy had a cash position of $18.9 million,
as compared to $0.8 million at December 31, 2005. Working capital at
December 31, 2006 was $3.3 million, as compared to a working capital of $0.7
million at December 31, 2005. Increased capital activities in Egypt and
Pakistan during the fourth quarter resulted in a higher level of accounts
payable at year end. At December 31, 2006, accounts receivable are higher as a
result of increased sales levels and represent normal industry collection
terms. Additionally, the Corporation secured long-term debt to replace
short-term borrowings, received proceeds from warrant and option exercises
($13.2 million) and converted debentures to equity.
    On May 19, 2006, Rally finalized loan agreements with the International
Finance Corporation (the "IFC") (a member of the World Bank Group) for the
provision of reserve-based long-term financing of up to US$25 million to fund
capital requirements and working capital needs for the Corporation's projects
in Egypt and Pakistan. The loan agreements consist of a US$5 million term
facility (expiring on October 15, 2010) and a revolving facility consisting of
two US$10 million tranches. The maturity date for both revolving facility
tranches is October 15, 2009. In connection with these credit facilities,
Rally issued 3,000,000 common share purchase warrants to IFC. Each Warrant
entitled IFC to purchase one share of the Corporation at a price of $1.92 per
share on or before May 19, 2009. Under the terms of the agreement, Rally
accelerated the expiry date of the Warrants as a result of the Corporation's
shares closing at or above $2.95 per share for ten consecutive trading days.
As a result of the expiry date being accelerated by Rally, IFC exercised all
of the Warrants on December 4, 2006. The aggregate exercise price for the
Warrants was $5.76 million. To fund this exercise price, IFC offset the amount
owing to it by Rally under the term facility (approximately $5.71 million
(US$5 million)) and paid Rally the balance owing of $52,500 in cash. At
December 31, 2006, the Corporation had fully drawn the remaining US$20 million
revolving facility in anticipation of cash requirements for the active capital
program in the fourth quarter, and the term facility has been terminated.
    By June 30, 2006, all outstanding Convertible Debentures either converted
to common shares (at $1.10/share) or were redeemed. The outstanding
Convertible Debentures had previously been classified as current due to their
maturity on July 1, 2006. In addition, the Corporation's previous US$7 million
short-term credit facility with a major Canadian bank was paid out and all
related security was discharged on June 30, 2006.
    During the 12 months ended December 31, 2006, Rally Energy received
proceeds of $1.1 million from the exercise of an aggregate of 1,484,000 common
share options and $12.1 million from the exercise of an aggregate of seven
million common share purchase warrants (four million warrants at $1.60 per
share and three million warrants, held by IFC, at $1.92 per share).
    With the recent closing of a $55 million equity financing, Rally Energy
currently expects to generate sufficient cash flow from operations to meet its
ongoing commitments and capital expenditures for 2007. In addition to
internally generated sources, additional funds may be required from
time-to-time to fund exploration and development activities. General market
conditions in effect at the time additional funds are sought could impact on
the Corporation's ability to raise additional funds either in equity or debt
form.

    Reserves

    At December 31, 2006, Rally Energy's reserves were evaluated by the
independent engineering firm of DeGolyer and MacNaughton Canada Limited
("D&M"). The 2006 drilling program in Egypt and the Pakistan acquisition
resulted in significant reserves additions, as compared to 2005. The following
information is prepared using D&M's forecast pricing assumptions. Additional
details on the Corporation's reserves, including constant dollar pricing, can
be viewed in the "Statement of Reserves Data and Other Oil and Gas
Information" report, when filed, at www.sedar.com and www.rallyenergy.com.

    
                           Reserves Reconciliation
                 (company interest reserves before royalties,
                         barrels of oil equivalent)
                                                                       Total
                                        Proved          Total       Proved &
                                     Producing         Proved       Probable
                                  -------------------------------------------
    Egypt:
      Opening balance                2,387,749     10,038,568     35,271,180
        Additions/revisions          2,066,296     25,369,000     58,019,912
        Production                  (1,632,924)    (1,632,924)    (1,632,924)
                                  -------------------------------------------
      Closing balance                2,821,121     33,774,644     91,658,168
                                  -------------------------------------------
                                  -------------------------------------------
    Pakistan:
      Opening balance                        -      8,327,579      9,778,833
        Additions                            -              -              -
        Acquisition (Disposition)            -      2,473,637      2,919,663
        Production                           -              -              -
                                  -------------------------------------------
      Closing balance                        -     10,801,216     12,698,496
                                  -------------------------------------------
                                  -------------------------------------------
    Canada:
      Opening balance                  235,541        277,771        615,042
        Additions/revisions                436         12,437         30,215
        Acquisition (Disposition)     (189,037)      (231,267)      (568,538)
        Production                     (46,504)       (46,504)       (46,504)
                                  -------------------------------------------
      Closing balance                      436         12,437         30,215
                                  -------------------------------------------
                                  -------------------------------------------

    Consolidated:
      Opening balance                2,623,290     18,643,918     45,665,055
        Additions/revisions          2,066,732     25,381,437     58,050,127
        Acquisition (Disposition)     (189,037)     2,242,370      2,351,125
        Production                  (1,679,428)    (1,679,428)    (1,679,428)
                                  -------------------------------------------
      Closing balance                2,821,557     44,588,297    104,386,879
                                  -------------------------------------------
                                  -------------------------------------------

    The valuations associated with these reserves and the finding costs, on
both a Proved and Proved plus Probable basis, are summarized below:

                           Net Present Value at 5%
                     (thousands of dollars before taxes)
                                                                       Total
                                        Proved          Total       Proved &
                                     Producing         Proved       Probable
                                  -------------------------------------------
    At December 31, 2006:
      Egypt                       $     45,147   $    303,262   $    566,969
      Pakistan                               -        140,060        149,385
      Canada                               (15)           179            573
                                  -------------------------------------------
        Total                     $     45,132   $    443,501   $    716,927
                                  -------------------------------------------
                                  -------------------------------------------

                           Net Present Value at 10%
                     (thousands of dollars before taxes)
                                                                       Total
                                        Proved          Total       Proved &
                                     Producing         Proved       Probable
                                  -------------------------------------------
    At December 31, 2006:
      Egypt                       $     42,443   $    249,175   $    428,278
      Pakistan                               -        105,799        109,221
      Canada                               (15)           171            528
                                  -------------------------------------------
        Total                     $     42,428   $    355,145   $    538,027
                                  -------------------------------------------
                                  -------------------------------------------



    Finding & Development Costs
    (thousands of dollars, unless otherwise stated)

                       2006  Change in                 Reserve     Finding &
                    Capital     Future      Total    Additions   Development
               Expenditures    Capital    Capital         (boe)  Cost ($/boe)
               --------------------------------------------------------------
    Egypt
      Proved
       reserves  $   45,804   $ 97,566   $143,370   25,369,000   $      5.65
      Proved &
       probable  $   45,804   $217,990   $263,794   58,019,912   $      4.55

    Pakistan
      Proved
       reserves  $   19,908   $   (735)  $ 19,173    2,473,637   $      7.75
      Proved &
       probable  $   19,908   $  2,034   $ 21,942    2,919,663   $      7.52

    Canada
      Proved
       reserves  $    4,376   $   (141)  $  4,235     (218,830)  $    (19.35)
      Proved &
       probable  $    4,376   $   (141)  $  4,235     (538,323)  $     (7.87)

    Consolidated
      Proved
       reserves  $   70,088   $ 96,690   $166,778   27,623,807   $      6.04
      Proved &
       probable  $   70,088   $219,883   $289,971   60,401,252   $      4.80
    


    Business Risks and Uncertainties

    Rally Energy is in the business of exploring for, developing and
producing oil and natural gas. The Corporation has production operations in
Egypt and Canada, as well as pre-production and exploration activities in
Pakistan. Along with the competitive nature of the oil and gas industry, risk
exposures, some of which are beyond the control of the Corporation, can be
categorized as operational, political, regulatory, environmental and
financial.
    The long-term commercial success of Rally Energy depends on its ability
to find, acquire, develop and commercially produce oil and natural gas
reserves. Oil and natural gas exploration involves a high degree of risk and
there is no assurance that expenditures made on future exploration by the
Corporation will result in new discoveries of oil or natural gas in commercial
quantities. It is difficult to project the costs of implementing an
exploratory drilling program due to the inherent uncertainties of drilling in
unknown formations, the costs associated with encountering various drilling
conditions and changes in drilling plans and locations as a result of prior
exploratory wells or additional seismic data and interpretations thereof.
    The process of evaluating prospects and estimating oil and natural gas
reserves is complex and subject to uncertainty. Actual operating results,
including production performance, may vary from those estimated, possibly
materially. Rally Energy manages these risks by having operational control,
where possible, and working interests commensurate with the assessed risk in
each project and by hiring qualified professionals, including independent
reserves engineers, with appropriate industry experience. The Corporation
focuses the majority of its activities on exploitation of identified
reservoirs.
    Some of the Corporation's operations and related assets are located in
countries which carry a higher degree of political and economic risk. Rally
Energy's management has considerable expertise operating internationally and
has developed solid, long-term relationships within each of the jurisdictions
in which it operates. The Corporation adheres to all governmental and
environmental regulations as they apply in each operating jurisdiction.
Regulation changes could increase costs of the Corporation's operations.
    Rally Energy's production base is heavily weighted to heavy oil produced
in Egypt which is subject to pricing based on international oil price
fluctuations. Oil and natural gas are commodities whose prices have fluctuated
widely in recent years and are determined based on world demand, supply and
other factors, all of which are beyond the control of the Corporation.
    Rally Energy maintains an insurance program which is consistent with
industry practice to provide adequate coverage of drilling, operations, safety
and the environment.

    Sensitivities

    The Corporation's cash flow is sensitive to changes in production,
commodity prices and currency exchange rates. The expected annual impact,
based on the 2006 fourth quarter information, is:

    
    (thousands of dollars, unless otherwise stated)
                                                                 Variance in
                                                  Variance in      Cash Flow
                                                    Cash Flow      per share
                                                 ----------------------------
    Oil Price(1)                                 $      1,696   $     0.0169
    Oil Production(2)                            $        799   $     0.0084
    Foreign Currency(3)                          $        318   $     0.0034

    (1) change of US$1/boe
    (2) change of 100 boe/d
    (3) $0.01 change in CDN$ in relation to US$
    


    Off Balance Sheet Items

    There are no off balance sheet assets or liabilities.


    Related Party Transactions

    Transactions between the Corporation and related parties occurred during
the year, as disclosed in Note 9 to the consolidated financial statements.
During 2006, the Corporation paid $279,000 (2005 - 1.0 million) as consulting
fees to related parties. All such transactions were in respect of technical
and specialized services rendered in the normal course of business operations
and represent consideration established and agreed to by the related parties
which is similar to those negotiated with third parties. Certain of the
payments relate to services provided on an as-needed basis; ongoing
contractual commitments with related parties are currently $14,000 per month.

    
    Contractual Obligations
      (thousands of dollars)

                                            Payments Due by Period
                                  -------------------------------------------
                                  Less Than                 After
                                     1 Year  1-5 Years    5 Years      Total
    -------------------------------------------------------------------------

    Office lease(1)               $     330  $   1,187          -  $   1,517
    Asset retirement
     obligations(2)                       -          -  $   1,302  $   1,302
    -------------------------------------------------------------------------

    (1) See Note 12(d) to the consolidated financial statements.
    (2) See Note 11 to the consolidated financial statements.
    


    CRITICAL ACCOUNTING ESTIMATES

    Rally Energy's significant accounting policies are disclosed in Note 2 to
the consolidated financial statements. 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. The following discusses such accounting
policies and is included in the MD&A to assist the reader in assessing our
critical accounting policies and practices and the likelihood of materially
different results being reported. As management, we review estimates
regularly. The emergence of new information and changed circumstances,
including accounting standards, may result in actual results or changes to
estimated amounts that differ materially from current estimates.

    Reserves Determination

    The petroleum and natural gas reserves used in determining our depletion
rates and the ceiling test are based upon management's best estimates, and are
subject to uncertainty. Through the use of geological, geophysical and
engineering data, the reservoirs and deposits of petroleum and natural gas are
examined to determine quantities available for future production, given
existing operating and economic conditions and technology. The evaluation of
recoverable reserves is an ongoing process impacted by current production,
continuing development activities and changing economic conditions as
reflected in crude oil and natural gas prices and costs. Consequently, the
reserves are estimates which are subject to variability. We employ the
services of independent oil and gas reservoir engineers (DeGolyer and
MacNaughton Canada Limited) to assist with the reserve evaluation process.

    Full Cost Accounting for Oil and Gas Activities

    Rally Energy 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 before royalties, as determined by
qualified independent petroleum evaluation engineers. Accordingly, changes in
estimated proved oil and gas reserves and estimated future development costs
would result in changes to the depletion rate.
    Certain costs related to unproved properties and major development
projects may be excluded from costs subject to depletion until proved reserves
have been determined or their value is impaired. These properties are assessed
periodically and any impairment is transferred to the costs subject to
depletion.

    Asset Impairments

    Under full cost accounting, a ceiling test is performed to ensure that
unamortized capitalized costs in each cost centre (country) do not exceed
their fair value. Impairment is recognized when the carrying value is greater
than the undiscounted future cash flows. In the event of impairment, the
amount by which the carrying value exceeds the estimated fair value of the
long-lived asset is charged to earnings. Fair value is determined using
expected future product prices and costs, and amounts are discounted using a
risk-free interest rate. At December 31, 2006 the impairment test was met for
the Egyptian and Pakistan properties capitalized costs and no ceiling test
write-down was required. A write-down of the Canadian assets was recorded at
December 31, 2006, as disclosed.

    Asset Retirement Obligations

    The fair value of the future retirement obligation is discounted to
present value and is recorded as an increase to the related property and
equipment with the corresponding balance recorded as a future asset retirement
obligation. The increased asset value is amortized according to our policies
for property and equipment and the future liability is accreted to expense
until the future retirement obligation is expected to be settled.

    Stock-Based Compensation

    The Corporation uses the fair value method for valuing stock option
grants. Under this method, compensation cost attributable to all stock options
granted is measured at fair value at the grant date, using the Black-Scholes
valuation model, and expensed over the vesting period with a corresponding
increase to contributed surplus. Upon exercise of options, consideration
received together with the amount previously recognized in contributed surplus
is recorded as an increase to share capital.

    Accounting for Derivative Instruments and Hedging Activities

    Rally Energy has not entered into any hedging arrangements.

    Income Tax Accounting

    The determination of the Corporation's income and other tax liabilities
requires interpretation of complex laws and regulations often involving
multiple jurisdictions. All tax filings are subject to audit and potential
reassessment after the lapse of considerable time. Accordingly, the actual
income tax liability may differ significantly from that estimated and recorded
by management.

    Legal, Environmental Remediation and Other Contingent Matters

    Rally Energy is required to both determine whether a loss is probable,
based on judgment and interpretation of laws and regulations, and determine
that the loss reasonably be estimated and included in the Corporation's
financial statements. Management continually monitors known and potential
contingent matters and makes appropriate provisions by charges to earnings
when warranted by circumstances.

    Disclosure Controls and Procedures

    Disclosure controls and procedures have been designed to ensure that
information required to be disclosed by the Corporation is accumulated and
communicated to the Corporation's management as appropriate to allow timely
decisions regarding required disclosures. The Corporation's Chief Executive
Officer ("CEO") and Chief Financial Officer ("CFO") have concluded, based on
their evaluation as of the end of the period covered by this MD&A, that the
Corporation's disclosure controls and procedures are effective to provide
reasonable assurance that material information related to the Corporation,
including its consolidated subsidiaries, is made known to them by others
within those entities. It should be noted that while the Corporation's CEO and
CFO believe that the Corporation's disclosure controls and procedures provide
a reasonable level of assurance that they are effective, they do not expect
that the disclosure controls and procedures or internal controls 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.

    Internal Controls over Financial Reporting

    The Corporation maintains a set of internal controls over financial
reporting which have been designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial
statements in accordance with Canadian GAAP. The Corporation, and independent
consultants, evaluated the design of its internal controls and procedures as
defined under Multilateral Instrument 52-109 for the year ended December 31,
2006. This evaluation was led by the CEO and CFO, with the assistance of other
employees, to the extent necessary and appropriate. Based on this evaluation,
the CEO and CFO concluded that the design of these internal controls and
procedures was effective. The results of this evaluation were presented to the
Audit Committee and the Corporation's Board of Directors. Additional testing
of the Corporation's internal controls over financial reporting, by
independent consultants, will be performed in 2007.
    There were no changes in the Corporation's internal control over
financial reporting that occurred during the fourth quarter that have
materially affected, or are reasonably likely to materially affect the
Corporation's internal control over financial reporting.

    2007 OUTLOOK

    The 2007 capital program will include drilling up to 30 conventional and
30 thermal wells in Egypt and a development and an exploration well in
Pakistan. In Egypt, additional thermal and production facilities are also
planned to accommodate higher production expected to result from phased
development of the thermal expansion cyclic steam stimulation ("CSS") program.
In addition to the existing 10 CSS wells at December 31, 2006, the 2007
drilling program will increase the CSS program to a total of 40 CSS wells by
the end of 2007. In Pakistan, production facilities will be completed to
accommodate gas production from the Salsabil development program. Exploration
drilling results on the Safed Koh Concession will determine any additional
production facility requirements.

    
    -------------------------------------------------------------------------

                                                          Rally Energy Corp.
                                                 Consolidated Balance Sheets

    As at December 31                                    2006           2005
    -------------------------------------------------------------------------
    Assets
    Current
      Cash and cash equivalents                  $ 17,743,645   $    801,639
      Restricted cash(Note 3)                       1,169,768              -
      Accounts receivable                          20,594,214      8,906,244
      Inventory(Note 5)                               617,427        305,061
      Prepaid expenses and deposits                   627,228        468,943
                                                 -------------  -------------
                                                   40,752,282     10,481,887

    Future income tax asset(Note 10)                        -        705,000
    Long-term investments(Note 4)                   1,905,500        150,000
    Property and equipment(Note 5)                 89,853,531     48,334,494
    Deferred charges(Note 7)                        2,568,325         26,440
                                                 -------------  -------------
                                                 $135,079,638   $ 59,697,821

    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Liabilities and Shareholders' Equity

    Current
      Accounts payable - operations              $  6,780,795   $  4,572,583
      Accounts payable - capital                   30,626,765      3,922,935
      Convertible debentures(Note 6)                        -      1,287,555
                                                 -------------  -------------
                                                   37,407,560      9,783,073

    Asset retirement obligations(Note 11)             770,740        590,382
    Long-term debt(Note 7)                         23,308,000              -
                                                 -------------  -------------
                                                   61,486,300     10,373,455
                                                 -------------  -------------
    Shareholders' equity
      Equity instruments(Note 8(b))                73,248,886     56,249,969
      Contributed surplus(Note 8(f))                3,130,482      1,968,082
      Deficit                                      (2,786,030)    (8,893,685)
                                                 -------------  -------------
                                                   73,593,338     49,324,366
                                                 -------------  -------------

                                                 $135,079,638   $ 59,697,821
    Commitments(Note 12)
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    The accompanying notes are an integral part of the consolidated financial
    statements


    -------------------------------------------------------------------------

                                                          Rally Energy Corp.
                               Consolidated Statements of Income and Deficit

    For the years ended December 31                      2006           2005
    -------------------------------------------------------------------------

    Oil and natural gas revenue                  $ 74,794,346   $ 34,898,825
      Less: Royalties and related
       credits                                    (24,318,725)   (12,141,874)
                                                 -------------  -------------
                                                   50,475,621     22,756,951
      Operating expenses                           13,233,436      6,719,395
                                                 -------------  -------------

                                                   37,242,185     16,037,556
                                                 -------------  -------------
    Expenses
      Administrative expenses:
        Administration                              5,166,852      3,630,385
        Stock-based compensation                    2,103,992      1,435,925
                                                 -------------  -------------
                                                    7,270,844      5,066,310
      Interest expense                                871,105        629,353
      Depletion, depreciation
       and accretion                               11,282,676      8,371,352
      Accretion expense on
       convertible debentures                          26,445        189,069
      Amortization of deferred
       charge                                         623,969         76,381
      Write-down of
       assets(Note 5)                              10,528,813              -
                                                 -------------  -------------
                                                   30,603,852     14,332,465
                                                 -------------  -------------

    Income before other items
     and taxes                                      6,638,333      1,705,091
                                                 -------------  -------------
                                                 -------------  -------------

    Other items
      Interest income                                 192,914         36,899
      Loss on foreign exchange                       (543,236)       (24,429)
      Write-down of long-term
       investments(Note 4)                           (144,500)      (500,000)
      Other recoveries (expenses)                     (35,856)        92,581

                                                     (530,678)      (394,949)
                                                 -------------  -------------

    Income before taxes                             6,107,655      1,310,142

    Future income tax
     recovery(Note 10)                                      -        231,000
                                                 -------------  -------------

    Net income for the year                         6,107,655      1,541,142

    Deficit, beginning of year                     (8,893,685)   (10,434,827)
                                                 -------------  -------------

    Deficit, end of year                         $ (2,786,030)  $ (8,893,685)
                                                 -------------  -------------

    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
    Income per share(Note 8(g))
      Basic                                      $      0.065   $      0.019
      Diluted                                    $      0.062   $      0.018
    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    The accompanying notes are an integral part of the consolidated financial
    statements


    -------------------------------------------------------------------------

                                                          Rally Energy Corp.
                                       Consolidated Statements of Cash Flows

    For the years ended December 31                      2006           2005
    -------------------------------------------------------------------------

    Cash flows from operating activities
      Net income for the year                    $  6,107,655   $  1,541,142
      Non-cash items:
        Future income taxes                                 -       (231,000)
        Stock-based compensation                    2,103,992      1,435,925
        Accretion expense on convertible
         debentures                                    26,445        189,069
        Amortization of deferred charges              623,969         76,381
        Depletion, depreciation and accretion      11,282,676      8,371,352
        Unrealized foreign exchange loss              427,499              -
        Write-down of assets                       10,673,313        500,000
                                                 -------------  -------------
                                                   31,245,549     11,882,869

    Changes in non-cash working capital balances
      Accounts receivable                         (11,687,970)    (2,402,475)
      Notes receivable                                      -        257,270
      Inventory                                      (312,366)       235,386
      Prepaid expenses and deposits                  (158,285)      (202,582)
      Accounts payable - operations                 2,208,212      1,435,032
                                                 -------------  -------------
                                                   21,295,140     11,205,500
                                                 -------------  -------------

    Cash flows from investing activities
      Oil and gas assets                          (70,088,311)   (22,668,084)
      Proceeds from sale of oil and gas interests   5,038,143              -
      Restricted cash increase                     (1,169,768)             -
      Changes in accounts payable - capital        25,824,593     (1,205,020)
                                                 -------------  -------------
                                                  (40,395,343)   (23,873,104)
                                                 -------------  -------------

    Cash flows from financing activity
      Issuance of equity instruments(Note 8(e))     7,529,958     13,116,822
      Bank debt increase(Note 7)                   29,015,500              -
      Increase in deferred financing charges         (947,981)             -
      Redemption of convertible debentures             (7,006)             -
                                                 -------------  -------------
                                                   35,590,471     13,116,822

    Foreign exchange loss on cash held in a
     foreign currency                                 451,738         (5,824)
                                                 -------------  -------------

    Increase in cash                               16,942,006        443,394

    Cash and cash equivalents, beginning of year      801,639        358,245
                                                 -------------  -------------

    Cash and cash equivalents, end of year       $ 17,743,645   $    801,639
                                                 -------------  -------------

    -------------------------------------------------------------------------
    -------------------------------------------------------------------------

    The accompanying notes are an integral part of the consolidated financial
    statements


    -------------------------------------------------------------------------
    -------------------------------------------------------------------------
                                                           Rally Energy Corp.
                                   Notes To Consolidated Financial Statements

    December 31, 2006 and 2005
    -------------------------------------------------------------------------
    1.  Nature of Operations
    -------------------------------------------------------------------------

        Rally Energy Corp. (the "Corporation") was incorporated on June 30,
        1989 pursuant to the Ontario Business Corporations Act. Since
        inception, the Corporation's efforts have been devoted to the
        acquisition, exploration, and development of petroleum and natural
        gas properties. The Corporation is listed on the Toronto Stock
        Exchange (RAL) and the Frankfurt Stock Exchange (RLE).

        Effective July 11, 2002, the Corporation completed the acquisition of
        Scimitar Hydrocarbons Corporation ("Scimitar") which has interests in
        oil production in Egypt and interests in natural gas properties in
        Pakistan. The Corporation has rights to certain oil and natural gas
        production in Egypt through a Petroleum Service Agreement ("PSA"),
        and in Pakistan through a Concession Agreement ("Concession").

    -------------------------------------------------------------------------
    2.  Significant Accounting Policies
    -------------------------------------------------------------------------

        The consolidated financial statements of the Corporation have been
        prepared by management in accordance with Canadian generally accepted
        accounting principles ("GAAP"). The preparation of consolidated
        financial statements in conformity with GAAP requires management to
        make estimates and assumptions that affect the amounts reported in
        the consolidated financial statements and accompanying notes.  Actual
        results could differ from those estimates. The consolidated
        financial statements have, in management's opinion, been properly
        prepared using careful judgment with reasonable limits of materiality
        and within the framework of the significant accounting policies
        summarized below.

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

        (b)   Property and equipment
              ----------------------
              The Corporation follows the full cost method of accounting for
              oil and natural gas activities whereby all costs associated
              with the acquisition of, exploration for, and the development
              of oil and natural gas reserves are capitalized on a country by
              country basis in three cost centres, Canada, Egypt and
              Pakistan.  Such costs include lease acquisitions, geological
              and geophysical expenditures, lease rentals on non producing
              properties, drilling, equipment, and technical consulting
              directly related to exploration and development activities.
              Proceeds from sales of oil and natural gas properties are
              recorded as reductions of capitalized costs unless the
              reduction of capitalized costs results in a change of 20% or
              more in the depletion rate.  In this case, a gain or loss would
              be recognized into income.

              For each cost centre, the Corporation applies an impairment
              test ("ceiling test") to determine if capitalized costs are not
              recoverable and exceed their fair value. Capitalized costs
              are not recoverable if they are greater than estimated
              undiscounted cash flows from future production of proved
              reserves plus the cost (net of impairment) of unproved
              properties excluded from depletion. Commodity prices used in
              calculating estimated cash inflows are based on quoted
              benchmark prices in the futures market. Costs used in
              estimating cash outflows are based on expected future
              production and other costs. An impairment loss is recognized if
              capitalized costs are greater than their recoverable amount.
              The impairment loss is measured as the amount by which
              capitalized costs exceed the fair value of proved and probable
              reserves plus the cost (net of impairment) of unproved
              properties excluded from depletion. Fair value is determined
              based on the present value of future cash flows, after
              deducting abandonment and site restoration costs, discounted at
              a risk free interest rate, adjusted for prevailing market
              conditions. Any reduction of value, as a result of the ceiling
              test, is charged to operations in the period of impairment.

              Depletion of petroleum and natural gas properties and
              amortization of well equipment is provided on a unit of
              production basis based on gross proved petroleum and natural
              gas reserves. Natural gas is converted to equivalent units of
              petroleum products at approximately six thousand cubic feet
              to one barrel of oil.

              Costs of acquiring and evaluating unproved properties are
              initially excluded from depletion calculations. These
              unevaluated properties are assessed periodically to ascertain
              whether impairment has occurred. When reserves are assigned or
              the property is considered to be impaired, the cost of the
              property or the amount of the impairment is added to costs
              subject to depletion.

              Capital assets are recorded at cost. Amortization is provided
              using a straight-line basis over the estimated useful lives of
              the assets at annual amortization rates of 10% to 30%.

        (c)   Asset retirement obligations
              ----------------------------
              The Corporation recognizes the fair value of an asset
              retirement obligation ("ARO") in the period in which it is
              incurred and a reasonable estimate of the fair value can be
              made. The fair value of the estimated ARO is recorded as a
              long-term liability, with a corresponding increase in the
              carrying amount of property and equipment. The liability amount
              is increased each reporting period due to the passage of time
              and the amount of accretion is charged to earnings in the
              period. Revisions to the estimated undiscounted cost would also
              be an increase or decrease to the ARO. Actual costs incurred
              upon settlement of the ARO are charged against the ARO to the
              extent of the liability recorded. Any difference between the
              actual costs incurred upon settlement of the ARO and the
              recorded liability is recognized in the Corporation's earnings
              in the period in which the settlement occurs.

        (d)   Joint ventures
              --------------
              The Corporation's activities in Canada and Pakistan are
              conducted jointly with others. These consolidated financial
              statements reflect only the Corporation's participating share
              of revenue and expenditures on these petroleum and natural gas
              interests.

        (e)   Income taxes
              ------------
              The Corporation follows the liability method of accounting for
              income taxes. Under this method, the Corporation records future
              income taxes for the effect of any difference between the
              accounting and income tax basis of an asset or liability, using
              the substantively enacted income tax rates expected to apply in
              the period in which the asset or liability is realized.
              Accumulated future income tax balances are adjusted to reflect
              changes in income tax rates that are substantively enacted with
              the adjustment being recognized in earnings in the period that
              the change occurs. The Corporation does not provide for foreign
              withholding taxes on the undistributed earnings of its foreign
              subsidiaries, as the Corporation intends to invest such
              earnings indefinitely in foreign operations.

        (f)   Flow-through equity instruments
              -------------------------------
              Expenditure deductions for income tax purposes related to
              exploratory activities funded by flow-through equity
              instruments are renounced to investors in accordance with
              income tax legislation. The Corporation provides for the future
              effect on income taxes related to flow-through equity
              instruments as a reduction of share capital and an increase in
              future income tax liabilities when the expenditures are
              renounced to subscribers.

        (g)   Revenue recognition
              -------------------
              For Egypt operations, title passes when the crude oil is
              delivered and accepted based on an agreed upon formula by the
              Egyptian General Petroleum Corporation ("EGPC"). When the
              Corporation produces more oil than that delivered, such
              production is recorded as inventory. In Canada, revenue is
              recognized when title passes from the Corporation to its
              customers. No revenue was derived from the Pakistan properties
              in 2006 or 2005. As is normal to the industry, the
              Corporation's oil production in Egypt and Canada is subject to
              royalties. In addition, Pakistan production will also be
              subject to a royalty.

        (h)   Stock-based compensation
              ------------------------
              The Corporation accounts for its stock-based compensation plan
              using the fair value method. Under this method, a compensation
              cost is charged for stock options granted with a corresponding
              increase to contributed surplus. Upon exercise of the stock
              options, consideration paid, together with the amount
              previously recognized in contributed surplus is recorded as an
              increase to share capital.

        (i)   Financial instruments
              ---------------------
              Financial instruments consist primarily of cash and cash
              equivalents, accounts receivable, deposits, long-term
              investments, accounts payable, accrued liabilities and
              long-term debt. There are no significant differences between
              the carrying value of these instruments and their estimated
              fair value. The Corporation has not entered into any hedging
              relationships.

        (j)   Foreign currency translation
              ----------------------------
              The Corporation uses the temporal method when translating
              foreign currency transactions as the financial statements of
              all its subsidiaries are considered to be integrated
              operations.

              Under this method, monetary items denominated in a foreign
              currency are translated into Canadian dollars at the rate of
              exchange in effect at the balance sheet date and non-monetary
              items are translated at rates of exchange in effect when the
              assets were acquired or obligations incurred. Revenues and
              expenses are translated at rates in effect at the time of the
              transactions. Foreign exchange gains and losses are included in
              the determination of earnings.

        (k)   Measurement uncertainty
              -----------------------
              The amounts recorded for depletion and depreciation of property
              and equipment, the asset retirement obligations and the ceiling
              test calculation are based on estimates of reserves, production
              rates, commodity prices, future costs, foreign currency
              exchange rates and other relevant assumptions. By their
              nature, these estimates are subject to measurement uncertainty
              and the effect on the consolidated financial statements of
              changes in such estimates in future periods could be
              significant.

              The financial statements include accruals based on the terms of
              existing joint venture and concession agreements, and the terms
              of the PSA. Due to varying interpretations of the definition of
              terms in these agreements the accruals made by management in
              this regard may be significantly different from those
              determined by the Corporation's partners. The effect on the
              financial statements resulting from such adjustments, if any,
              is reflected prospectively.

              The Black-Scholes option valuation model was developed for use
              in estimating the fair value of traded options which were fully
              tradable with no vesting restrictions. This option valuation
              model requires the input of highly subjective assumptions
              including the expected stock price volatility.

              The Corporation's stock options and performance incentive
              warrants have characteristics significantly different from
              those of traded options and because changes in the subjective
              input assumptions can materially affect the calculated fair
              value, such value is subject to measurement uncertainty

        (l)   Cash and cash equivalents
              -------------------------
              Cash and cash equivalents include short-term, highly liquid
              investments that mature within three months of their purchase.
              They are recorded at cost, which approximates market value.

        (m)   Transportation costs
              --------------------
              Costs to transport petroleum products are recognized when the
              products are delivered and the services provided.

        (n)   Inventories
              -----------
              Inventories of petroleum products, operating supplies and raw
              materials are valued at the lower of cost and net realizable
              value. Cost is determined based on the average per barrel
              cost of production for the month.

        (o)   Deferred charges
              ----------------
              Deferred charges relate to the long-term credit facility, as
              described in Note 7, and are amortized over the life of the
              facility. In 2005, the deferred charges related to the
              convertible debentures and were amortized over their term,
              adjusted for conversions.

        (p)   Long-term investments
              ---------------------
              Long-term investments are carried at cost (Note 4) and reviewed
              regularly for any loss in value of the investments that is
              other than a temporary decline. If a loss in value that is
              other than a temporary decline, the investment will be written
              down to the value, and the impairment included in the
              determination of earnings.

    -------------------------------------------------------------------------
    3.  Restricted Cash
    -------------------------------------------------------------------------

        As security for letters of credit issued to secure equipment orders
        for Egyptian drilling operations and work commitments in Pakistan,
        $1,169,768 is held on deposit with Canadian and Foreign chartered
        banks. The funds are invested in interest-bearing revolving term
        deposits. The letters of credit will expire on or before July 31,
        2007.

    -------------------------------------------------------------------------
    4.  Long-term Investments
    -------------------------------------------------------------------------

        On December 15, 2006, the Corporation completed the sale of certain
        Canadian oil and gas assets for a purchase price of $6.9 million,
        with an effective date of December 1, 2006. Proceeds from the
        disposition were settled by way of $5 million in cash and
        $1.9 million in equity from the arms-length purchaser, a private
        Canadian company.

        The Corporation holds a minority equity position in a registered
        public company resulting from an asset disposition in February 2005.
        At December 31, 2006 the valuation was reviewed and it was determined
        that the carrying value should be written-down by $144,500 as a
        result of a decline in the company's common share price.

    -------------------------------------------------------------------------
    5.  Property and Equipment
    -------------------------------------------------------------------------

        The Corporation holds various working interests in developed and
        undeveloped petroleum and natural gas properties and facilities and
        has deferred costs related to the PSA, the Concession and Canada. The
        carrying amounts of these assets are as follows:

                                                        2006            2005
        ---------------------------------------------------------------------
        Petroleum and natural gas assets       $ 130,283,985   $  69,248,722
        Furniture, machinery and equipment         4,896,264       2,855,712
                                               ------------------------------
                                                 135,180,249      72,104,434
        Accumulated depletion, depreciation
         and write-downs                         (45,326,718)    (23,769,940)
                                               ------------------------------
        Net book value (Note 14)               $  89,853,531   $  48,334,494
                                               ------------------------------
                                               ------------------------------

        The expenditures deferred in Egypt are being depleted on a unit-of-
        production basis. These costs include exploration, drilling and
        equipping costs. All other capital expenditures are also capitalized
        under the terms of an agreement between The General Petroleum Co.
        S.A.E. ("GPC") and a wholly-owned subsidiary of the Corporation,
        Scimitar Production Egypt Ltd. ("Scimitar Egypt"). Scimitar Egypt has
        the right to explore and exploit the concession area for an initial
        term of 20 years (Note 12(a)) plus two additional five-year terms.
        The renewals are subject to GPC approval. The depletion factor used
        to deplete these assets is based on the production expected to be
        achieved over the next 12 years. At the end of each year, the
        ownership of all assets, tangibles and intangibles reverts to GPC. It
        is intended that the deferred expenditures will be fully depleted by
        the end of the concession term, and that assets under lease will be
        either returned to lessors or re-leased by GPC.

        The Corporation has recorded deferred exploration and development
        expenditures of $21,546,349 (2005 - $1,638,638) in Pakistan. These
        costs will be depleted on a unit-of-production basis when production
        commences in Pakistan.

        During the year ended December 31, 2006, the Corporation capitalized
        general and administrative expenditures in Canada of $1,094,037
        (2005 - $624,918), which were included in petroleum and natural gas
        assets. The Corporation did not capitalize any general and
        administrative expenditures related to its Egypt properties. For the
        Pakistan properties, general and administrative expenditures in the
        amount of $485,527 (2005 - $312,713) were capitalized in 2006. No
        interest has been capitalized.

        At December 31, 2006, the Corporation held $7,117,814 (2005 -
        $2,126,159) of inventory available for future capital expenditures in
        the Issaran oilfield in Egypt. Of this amount, (i) $6,500,387 (2005 -
        $1,821,098) relates to capital equipment, primarily pipe, and is
        included in property and equipment and (ii) $617,427 (2005 -
        $305,061) represents consumable supplies to be used in oilfield
        operations and is recorded as inventory under current assets. The
        capital inventory is being utilized in the Corporation's ongoing
        drilling program. No amortization has been taken on such inventory.

        Costs of unproved petroleum and natural gas properties, primarily in
        Canada, amounting to $nil (2005 - $65,966) have been excluded from
        the depletion calculation.

        Impairment calculations were performed on the Corporation's petroleum
        and natural gas properties at December 31, 2006 and 2005 in which the
        estimated undiscounted future net cash flows associated with the
        proved and probable reserves exceeded the carrying amount of the
        Corporation's property and equipment in Egypt and Pakistan.

        At December 31, 2006, the Corporation recorded a write-down of
        $10,528,813 related to valuation impairments associated with the
        carrying value of Canadian petroleum and natural gas assets.

        The following table outlines benchmark prices used in the impairment
        test at December 31, 2006:

                              Issaran          WTI         AECO     Pakistan
                             Wellhead    Crude Oil  Natural Gas  Natural Gas
        Year                  US$/bbl      US$/bbl     CAD$/mcf      US$/mcf
        ---------------------------------------------------------------------
        2007                    36.66        65.00         7.32         3.47
        2008                    36.95        65.52         7.91         3.47
        2009                    36.25        64.27         7.72         3.47
        2010                    34.82        61.73         7.48         3.47
        2011                    33.32        59.07         7.68         3.47
        Thereafter
         (inflation %)             2%           2%           2%           0%


    -------------------------------------------------------------------------
    6.  Convertible Debentures
    -------------------------------------------------------------------------

        During 2006, $1,306,994 of Convertible Debentures converted to common
        shares (at $1.10/share) and $7,006 were redeemed by June 30, 2006.
        Issued on June 13, 2003, the 12% unsecured convertible subordinated
        debentures were entitled to semi-annual interest payments and matured
        on July 1, 2006.

    -------------------------------------------------------------------------
    7.  Long-Term Debt
    -------------------------------------------------------------------------

        On May 19, 2006, the Corporation finalized agreements with the
        International Finance Corporation ("IFC"), (a member of the World
        Bank Group), for US$25 million of long-term financing facilities. The
        facilities are comprised of a US$5 million Term Loan ("Term") to the
        Corporation and a US$20 million Revolving Credit Facility
        ("Revolving") to two of its wholly-owned subsidiaries, Scimitar
        Production Egypt Ltd. ("SPEL") and Rally Energy Safed Koh Ltd.
        ("RESK"). The Term loan matures in its entirety on October 15, 2010
        and requires semi-annual interest payments calculated at LIBOR plus
        2.75%. The Revolving loan, comprised of two US$10 million tranches,
        matures on October 15, 2009 and requires semi-annual interest
        payments at LIBOR plus 2.75%. A 1.3125% standby fee on the unused
        portion of the available Revolving loan is payable semi-annually.
        Setup costs of $3,165,854 pertaining to these facilities, including
        the value attributed to the share purchase warrants (Note 8(e)), have
        been recorded as deferred financing charges and will be amortized
        over the life of the Revolving facility. The effective interest rate
        of the IFC revolving credit facility at December 31, 2006 is 8.025%.

        This reserve-based facility is secured by proceeds from oil and gas
        sales, shares of SPEL and RESK and the Corporation's rights under the
        Issaran PSA and the Safed Koh Concession Agreement. Additionally,
        SPEL and RESK, collectively, have provided a US$20 million debenture
        creating first ranking fixed and floating charges, along with a
        guarantee from the Corporation.

        On December 4, 2006, IFC utilized the fully-drawn US$5 million Term
        loan as payment proceeds to exercise warrants, as more fully
        described in Note 8(e). The Term loan facility was terminated on
        December 4, 2006.

        At December 31, 2006, US$20 million was drawn under the Revolving
        loan.

        The Corporation's previous US$7 million credit facility with a major
        Canadian bank was paid out and all related security was discharged on
        June 30, 2006.

    -------------------------------------------------------------------------
    8.  Equity Instruments
    -------------------------------------------------------------------------


        (a)   Authorized
              ----------
              Unlimited number of voting Common Shares
              Unlimited number of voting Convertible Preference Shares,
              cumulative preferential dividend at the rate of $0.06 per share
              per annum, redeemable by the Corporation.

        (b)   Issued and outstanding
              ----------------------

                              2006                            2005
               ------------------------------  ------------------------------
                   Number of                       Number of
                      Shares         Amounts          Shares         Amounts
               ------------------------------  ------------------------------
    Common shares
    Balance,
     beginning
     of year      91,025,379   $  56,908,614      74,350,379   $  38,332,943
    Private
     placement -
     flow-through
     shares                -               -       1,120,000       2,016,000
    Private
     placement             -               -         732,000         966,240
    Prospectus
     issue
     (Note 8(d))           -               -       8,000,000       9,095,758
    Stock options
     exercised
     (Note 8(c)
     and (f))      1,484,093       1,589,758       2,137,000       1,811,673
    Debentures
     converted
     (Note 6
     and 8(f))     1,188,176       1,743,993       4,686,000       4,686,000
    Warrants
     exercised
     (Note 8(d)
     and (e))      7,000,000      15,282,115               -               -
               ------------------------------  ------------------------------
                 100,697,648      75,524,480      91,025,379      56,908,614
               ------------------------------  ------------------------------

    LESS: Share
     issue costs           -      (2,275,594)              -      (1,562,887)
               ------------------------------  ------------------------------
                 100,697,648      73,248,886      91,025,379      55,345,727
               ------------------------------  ------------------------------
    Share
     purchase
     warrants -
     common
     shares
    Balance,
     beginning
     of year       4,000,000         904,242               -               -
    Issued
     (Note 8(e))   3,000,000       2,217,873       4,000,000         904,242
    Exercised     (7,000,000)     (3,122,115)              -               -
               ------------------------------  ------------------------------
                           -               -       4,000,000         904,242
               ------------------------------  ------------------------------
               --------------                  --------------

    Balance,
     end of year,
     all equity
     instruments               $  73,248,886                   $  56,249,969
                               --------------                  --------------
                               --------------                  --------------


        (c)   Options
              -------
              The shareholders of the Corporation have approved a formal 10%
              rolling stock option plan under which directors, officers,
              employees and consultants are eligible to receive grants. Stock
              option agreements have vesting periods varying from immediate
              to three years and expiration terms vary to five years, with a
              weighted average life of 2.64 (2005 - 3.27) years.

                                     2006                      2005
                           ------------------------  ------------------------
                                          Weighted                  Weighted
                                           Average                   Average
                                Share     Exercise        Share     Exercise
                              Options        Price      Options        Price
                           ------------------------  ------------------------
              Outstanding,
               beginning
               of year      7,356,759        $1.02    6,327,757        $0.63
                Granted     1,165,000        $2.36    3,361,000        $1.48
                Exercised  (1,484,093)       $0.73   (2,137,000)       $0.60
                Cancelled    (175,000)       $1.34     (194,998)       $0.93
                           ------------------------  ------------------------
              Outstanding,
               end of year  6,862,666        $1.30    7,356,759        $1.02
                           ------------------------  ------------------------
                           ------------------------  ------------------------


                                     Options Outstanding
            -----------------------------------------------------------------
                             2006                          2005
            -------------------------------- --------------------------------
                                    Weighted                         Weighted
               Number of Options    Average     Number of Options    Average
    Exercise  -------------------   Years to   -------------------   Years to
    Price   Outstanding Exercisable  Expiry  Outstanding Exercisable  Expiry
    ---------------------------------------- --------------------------------
    $0.54     150,000    150,000       0.17    200,000    150,000       2.76
    $0.60   1,293,000  1,293,000       0.86  2,245,000  2,170,000       1.60
    $0.61     257,000    257,000       1.83    451,667    451,667       2.38
    $0.76     815,000    815,000       2.67    865,000    793,334       3.49
    $0.80     240,000    240,000       1.25    240,000    240,000       2.25
    $0.88           -          -          -     34,091     34,091       0.25
    $1.32     500,000    500,000       3.54    500,000    250,000       4.54
    $1.34     958,000    958,000       4.00  1,208,000    604,000       5.00
    $1.40     243,333    140,001       3.71    310,000    103,334       4.71
    $1.54     250,000    166,668       3.33    250,000     83,334       4.33
    $1.55     318,333    240,002       3.83    335,000    111,670       4.83
    $1.79     498,000    332,005       3.04    543,001    211,008       3.77
    $1.85     175,000    116,667       3.21    175,000     58,334       4.21
    $2.30   1,105,000    865,000       4.46          -          -          -
    $3.49      60,000     30,000       4.83          -          -          -
            -------------------------------- --------------------------------
            6,862,666  6,103,343       2.64  7,356,759  5,260,772       3.27
            -------------------------------- --------------------------------
            -------------------------------- --------------------------------

              The Corporation recorded an expense of $2,103,992 for options
              issued in 2006 (2005 - $1,435,925). The stock-based
              compensation expense associated with the value ascribed to
              options granted is recorded as contributed surplus. The fair
              value of share options was estimated using the Black-Scholes
              option-pricing model with the following assumptions: dividend
              yield (nil) (2005 - nil), volatility (48% to 50%) (2005 - 38%
              to 56%), risk-free interest rate (5%) (2005 - 5%), and weighted
              average life of 5 years (2005 - 5 years). The weighted average
              fair value at grant date of the options issued was $1.17
              (2005 - $0.69).

        (d)   Prospectus issue - common shares and purchase warrants
              ------------------------------------------------------
              On December 19, 2005, the Corporation issued 8,000,000 units
              priced at $1.25 per unit for gross proceeds of $10,000,000.
              Each unit consisted of one common share and one-half of a
              common share purchase warrant. Each full warrant was
              exercisable for $1.60 per common share on or before
              December 19, 2006. Under the terms of the agreement, the
              Corporation accelerated the expiry date of the warrants to
              July 20, 2006 as a result of the Corporation's common shares
              closing above $1.80 per share for ten consecutive trading days.
              Prior to their expiry, all the warrants were exercised for an
              aggregate exercise price of $6.4 million.

        (e)   Credit facility - common share purchase warrants
              ------------------------------------------------
              In connection with the IFC credit facilities (Note 7), the
              Corporation issued three million common share purchase warrants
              to IFC on May 19, 2006. Each warrant entitled IFC to purchase
              one common share of the Corporation at a price of $1.92 per
              common share until May 19, 2009. Under the terms of the
              agreement, the Corporation accelerated the expiry date of the
              warrants as a result of the Corporation's common shares closing
              at or above $2.95 per share for ten consecutive trading days.
              IFC exercised all of the warrants on December 4, 2006 for an
              aggregate exercise price of $5.76 million. To fund this
              exercise price, IFC offset the amount owing to it by the
              Corporation under the Term facility (approximately
              $5.71 million) and $52,500 in cash. A value of $2,217,873 has
              been attributed to these warrants. The fair value of the
              warrants was estimated using the Black-Scholes option-pricing
              model with the following assumptions: dividend yield (nil),
              volatility (50%), and a risk-free interest rate (5%).

        (f)   Contributed surplus
              -------------------
                                                      2006            2005
                                               --------------  --------------
              Balance, beginning of year       $   1,968,082   $   1,063,620
                Stock-based compensation expense   2,103,992       1,435,925
                Options exercised, transferred
                 to share capital                   (504,592)       (531,463)
                Debentures exercised,
                 transferred to share capital       (437,000)              -
                                               --------------  --------------
                Balance end of year            $   3,130,482   $   1,968,082
                                               --------------  --------------
                                               --------------  --------------

        (g)   Per share amounts
              -----------------
              The income per share figures has been calculated using the
              weighted average number of common shares outstanding during the
              periods. Diluted per share amounts reflect the potential
              dilution that could occur if in-the-money securities or other
              contracts to issue common shares were exercised or converted to
              common shares. The treasury stock method is used to determine
              the dilutive effect of stock options and other dilutive
              instruments. Anti-dilutive options or instruments are not
              included in the calculation.

              The following table summarizes the calculation of basic net
              income and diluted net income per share.

                                                     2006            2005
                                               --------------  --------------
              Net income available to common
               shareholders                    $   6,107,655   $   1,541,142
                                               --------------  --------------
                                               --------------  --------------
              Weighted-average number of common
               shares outstanding - basic         94,660,474      80,261,218
              Dilution effect of stock options     3,294,494       1,965,623
              Dilution effect of convertible
               debentures                                  -       1,194,546
                                               --------------  --------------
              Weighted-average number of common
               shares outstanding - diluted       97,954,968      83,421,387
                                               --------------  --------------
              Net income per share ($/share)
                Basic                          $       0.065   $       0.019
                                               --------------  --------------
                Diluted                        $       0.062   $       0.018
                                               --------------  --------------

              Outstanding stock options are the only instruments that are
              currently dilutive to earnings per share. For 2006, no stock
              options were antidilutive and excluded from the computation of
              diluted earnings per share (2005 - 1,303,001)

    -------------------------------------------------------------------------
    9.  Related Party Transactions
    -------------------------------------------------------------------------

        (a)   Except as noted elsewhere in these financial statements, the
              Corporation was involved in the following related party
              transactions:
                                                     2006            2005
                                               --------------  --------------
              Consulting fees paid to companies
               whose shareholders are directors
               and officers of the Corporation:
                Included in general and
                administrative expenses        $     135,925   $     516,233
                Capitalized (Note 5)                 142,875         530,174
                                               --------------  --------------
                                               $    278,800    $   1,046,407
                                               --------------  --------------
                                               --------------  --------------

              The above transactions occurred in the normal course of
              business operations and represent consideration established and
              agreed to by the related parties which is similar to those
              negotiated with third parties.

    -------------------------------------------------------------------------
    10. Income Taxes
    -------------------------------------------------------------------------

        The provision for income taxes differs from the amount obtained by
        applying the combined Federal and Provincial income tax rates to
        income before income taxes. The difference relates to the following
        items:

                                                      2006           2005
                                               --------------  --------------
        Income before taxes                    $    6,107,655  $   1,310,142
                                               --------------  --------------
        Corporate tax rate                              32.5%          37.6%
        Expected income tax                         1,984,988        492,613
        Stock compensation                            683,797        540,195
        Canadian resource related items                 9,952        (17,207)
        Foreign income                             (7,840,123)    (2,216,281)
        Rate changes and other                        715,586         39,000
        Expiration of non-capital loss                      -         81,680
        Change in valuation allowance               4,445,800        849,000
                                               --------------  --------------
                                               $            -  $    (231,000)
                                               --------------  --------------
                                               --------------  --------------

        At December 31, 2006, the Corporation has exploration and development
        expenditures (direct and successored) and undepreciated capital costs
        which may be carried forward indefinitely to reduce future Canadian
        taxable income:

                                                     2006            2005
                                               --------------  --------------
        Canadian oil and natural gas property
         expenses (COGPE)                      $   4,905,600   $   5,499,400
        Canadian development expenses (CDE)        3,237,800       1,909,300
        Canadian exploration expenses (CEE)        4,509,100       6,037,300
        Undepreciated capital costs                2,323,500       1,138,600
        Loss carryforwards expiring between
         2007 and 2016                             5,556,800       8,413,600
        Share issue costs                          1,327,500       1,473,800
                                               --------------  --------------
                                               $  21,860,300   $  24,472,000
                                               --------------  --------------
                                               --------------  --------------

        The components of the net future income tax asset and liability in
        Canada are as follows:
                                                     2006            2005
                                               --------------  --------------
        Loss carryforwards                     $   1,694,800   $   2,882,000
        Share issue costs                            376,800         496,000
        Carrying value of property and equipment
         in excess of tax basis                    3,690,200      (1,357,000)
                                               --------------  --------------
                                                   5,761,800       2,021,000
        Valuation allowance                       (5,761,800)     (1,316,000)
                                               --------------  --------------
        Net future income tax asset            $           -   $     705,000
                                               --------------  --------------
                                               --------------  --------------

        Under the terms of the PSA with GPC, the payment received on account
        of production in Egypt is not subject to income tax. All production
        in Egypt is subject to a royalty charge pursuant to the terms of the
        PSA, which satisfies all tax liabilities.

        In Pakistan, the Corporation has accumulated total costs of
        $22,757,174, the majority of which are deductible from future income
        tax obligations in Pakistan.

    -------------------------------------------------------------------------
    11. Asset Retirement Obligations
    -------------------------------------------------------------------------

        The Corporation has asset retirement obligations in Egypt (resulting
        from the PSA), Pakistan (resulting from the Concession Agreement) and
        in Canada, from net ownership interests in petroleum and natural gas
        assets. The Corporation estimates the total undiscounted amount of
        cash flows required to settle its asset retirement obligations and
        time frame, is as follows. A credit-adjusted risk-free rate of 7% and
        an inflation rate of 2% were used to calculate the fair value of the
        asset retirement obligations.

                                            Cost Incurrence
                      Asset Retirement      ---------------
                           Obligations      Range    Majority
                           -----------      -----    --------
              Egypt       $  1,222,824    2015-2018    2018
              Pakistan          39,332    2015-2020    2020
              Canada            40,000    2009-2014    2014
                          -------------
                          $  1,302,156
                          -------------
                          -------------

        A reconciliation of the asset retirement obligations is provided
        below:

        Asset retirement obligations                 2006            2005
                                               --------------  --------------
        Balance, beginning of year             $     590,382   $     289,846
        Liability adjustments from prior year         57,829          33,562
        Liability adjustments from disposition
         of assets                                  (186,486)              -
        Liabilities incurred in year, net            282,591         243,992
        Accretion expense                             26,424          22,982
                                               --------------  --------------
        Balance, end of year                   $     770,740    $    590,382
                                               --------------  --------------
                                               --------------  --------------

    -------------------------------------------------------------------------
    12. Commitments
    -------------------------------------------------------------------------

        (a)   Scimitar Egypt, a wholly-owned subsidiary of the Corporation,
              entered into a PSA with GPC effective November 4, 1998,
              pursuant to which the Corporation is granted the exclusive
              right to develop and produce heavy oil from the Issaran, Egypt
              oilfield. On October 18, 2001, the Corporation entered the
              Commercial Development Period of the PSA, after having
              successfully satisfied the terms of the three-year Piloting
              Period. The Corporation has the option to extend the 20-year
              term of the PSA (commencing from November 4, 1998) for up to
              two additional five-year terms subject to the concurrence of
              GPC. The Commercial Development Period does not require any
              specific capital expenditure commitments. Effective July 1,
              2004, a revised pricing agreement was negotiated for all oil
              sales from the Issaran oilfield in Egypt for a five-year period
              ending June 30, 2009. Under this pricing formula, for average
              monthly sales less than 2,000 bbls/d, the Corporation's
              realized oil price is 82% of the Ras Gharib blend price. For
              incremental monthly sales between 2,001 and 3,000 bbls/d, the
              realized oil sales price increases to 85% of the Ras Gharib
              blend price. The realized sales price increases again to 88% of
              the Ras Gharib blend price for incremental monthly sales that
              exceed 3,000 bbls/d.

        (b)   In November 2001, an 80% interest in an Exploration License
              over the Safed Koh Block in Pakistan was awarded to a wholly-
              owned subsidiary of the Corporation. The corresponding
              Concession Agreement was finalized in January 2002. The
              commitment fulfilled during the evaluation period was to carry
              out certain activities, including a review of existing
              geological, geophysical and well data. In 2004, an arrangement
              was negotiated whereby a new partner, as operator, committed to
              future expenditures of up to US$2.2 million, and the
              Corporation will have a 22.5% carried interest for its share of
              the project expenditure commitment. During 2005, Phase I of the
              exploration program was completed by re-entering two wells and
              testing commercial natural gas and condensate discoveries. In
              January 2006, the Government of Pakistan approved the
              "Declaration of Commercial Discovery and Development Plan" for
              the field. The Corporation and its partners have committed to
              drill two additional wells under Phase II of the exploration
              program. On October 20, 2005, the Corporation increased its
              interest in the Concession Agreement to 30% (Note 16(a)).

        (c)   The Corporation is required to make revenue-based royalty
              payments from the Issaran Oilfield to Gemini Oil and Gas
              Limited, an independent oil and natural gas investment fund.
              The revenue-based royalty of 10%, to a maximum of
              US$1.5 million in each of 2005 and 2006, is reduced to 2.6% of
              Issaran oil revenues (net of marketing fees and GPC
              entitlements), from a maximum of 7,000 bbls/d of production,
              commencing January 1, 2007 and continuing until December 31,
              2012. In 2006, royalties of $1.7 (US$1.5) million (2005 -
              $1.8 (US$1.5) million) were paid.

        (d)   The Corporation and two wholly-owned subsidiaries rent premises
              under operating leases for office premises, requiring the
              following payments:

                    Canada            Egypt         Pakistan         Total
               --------------------------------------------------------------
        2007   $     208,576   $     108,000   $      13,500   $     330,076
        2008         208,576         111,500               -         320,076
        2009         208,576         114,000               -         322,576
        2010         208,576         114,000               -         322,576
        2011         173,813          47,500               -         221,313
               --------------------------------------------------------------
               $   1,008,117   $     495,000   $      13,500   $   1,516,617
               --------------------------------------------------------------
               --------------------------------------------------------------

        (e)   In February 2004, a wholly-owned subsidiary of the Corporation
              entered into a consulting agreement with a then director of
              Scimitar Egypt to provide advisory services. The agreement
              requires payments, to a maximum of US$300,000 annually,
              calculated as to US$0.10/bbl of Issaran sales and an increment
              representative of the Issaran field price in excess of 80% of
              the Ras Gharib oil price. In 2006, marketing fees of US$19,082
              (2005 - US$63,774) were paid in respect to this agreement. The
              agreement terminated on February 23, 2006.

        (f)   In the ordinary course of business, the Corporation and its
              subsidiaries enter into contracts which contain indemnification
              provisions, such as loan agreements, purchase contracts,
              service agreements, licensing agreements, asset purchase and
              sale agreements, joint venture agreements, operating
              agreements, leasing agreements, land use agreements, etc. In
              such contracts, the Corporation may indemnify counterparties to
              the contracts if certain events occur. These indemnification
              provisions vary on an agreement by agreement basis. In some
              cases, there are no pre-determined amounts or limits included
              in the indemnification provisions and the occurrence of
              contingent events that will trigger payment under them is
              difficult to predict. Therefore, the maximum potential future
              amount that the Corporation could be required to pay cannot be
              estimated.

        (g)   Under the terms of the by-laws of the Corporation, the
              Corporation indemnifies individuals who have acted at the
              Corporation's request to be a director and/or officer of the
              Corporation (and/or one or more of its direct and indirect
              subsidiaries), to the extent permitted by law, against any and
              all damages, liabilities, costs, charges or expenses suffered
              by or incurred by the individuals as a result of their service.
              The claims covered by such indemnifications are subject to
              statutory and other legal limitation periods. The nature of the
              indemnification agreements prevents the Corporation from making
              a reasonable estimate of the maximum potential amount it could
              be required to pay to beneficiaries of such indemnification
              agreements. The Corporation has purchased various insurance
              policies to reduce the risks associated with such
              indemnifications.

    -------------------------------------------------------------------------
    13. Segmented Information
    -------------------------------------------------------------------------

        The Corporation operates in the petroleum and natural gas industry
        and has operations in Egypt, Pakistan and Canada. Its reportable
        segments are identified on a geographic basis. Gross revenue and
        income (loss) for the year ended and capital assets are summarized on
        a country basis below:

    2006               Egypt        Canada         Pakistan          Total
    -------------------------------------------------------------------------
    Gross
     revenue   $  72,415,056   $   2,379,290   $           -   $  74,794,346
               --------------------------------------------------------------
               --------------------------------------------------------------
    Income
     (loss)    $  24,578,941   $ (18,015,801)  $    (455,485)  $   6,107,655
               --------------------------------------------------------------
               --------------------------------------------------------------
    Property
     and
     equipment $  67,671,654   $     635,528   $  21,546,349   $  89,853,531
               --------------------------------------------------------------
               --------------------------------------------------------------

    2005               Egypt        Canada         Pakistan          Total
    -------------------------------------------------------------------------
    Gross
     revenue   $  31,879,199   $   3,019,626   $           -   $  34,898,825
               --------------------------------------------------------------
               --------------------------------------------------------------
    Income
     (loss)    $   5,965,291   $  (4,581,128)  $     (74,021)  $   1,310,142
               --------------------------------------------------------------
               --------------------------------------------------------------
    Property
     and
     equipment $  30,153,344   $  16,542,512   $   1,638,638   $  48,334,494
               --------------------------------------------------------------
               --------------------------------------------------------------

    -------------------------------------------------------------------------
    14. Financial Instruments
    -------------------------------------------------------------------------

        As disclosed in Note 2(i), the Corporation holds various forms of
        financial instruments. The nature of these instruments and the
        Corporation's operations expose the Corporation to normal industry
        credit risks. The Corporation manages its exposure to these risks by
        operating in a manner that minimizes its exposure to the extent
        practical.

        (a)   Credit risk
              -----------
              A significant portion of the Corporation's trade accounts
              receivable are from EGPC, a company wholly-owned by the Arab
              Republic of Egypt, and from working interest partners in the
              oil and natural gas industry and, as such, the Corporation is
              exposed to all the risks associated with that industry. In
              addition, 94% (2005 - 86%) of trade receivables are due from
              one customer. Revenues resulting from the PSA and paid by EGPC,
              represented 97% (2005 - 91%) of consolidated revenues. With
              respect to counterparties to financial instruments, the
              Corporation partially mitigates associated credit risk by
              limiting transactions to counterparties with investment grade
              credit ratings.

        (b)   Commodity price risk
              --------------------
              The Corporation's operational results and financial condition
              are dependent on the prices received for the delivery of
              natural gas and crude oil. Oil and gas prices have fluctuated
              widely during recent years and are determined by economic and,
              in the case of oil prices, political factors. Supply and demand
              factors, including weather and general economic conditions as
              well as conditions in other oil and natural gas regions impact
              prices. Any movement in oil and natural gas prices could have
              an effect on the Corporation's financial condition. The
              Corporation may manage the risk associated with changes in
              commodity prices by entering into oil or natural gas price
              derivatives. To the extent that the Corporation engages in risk
              management activities related to commodity prices, it will be
              subject to credit risks associated with counterparties with
              which it contracts. There were no hedges during 2006 or
              outstanding at year-end.

        (c)   Foreign currency exchange and interest rate risk
              ------------------------------------------------
              The Corporation's core operations are located outside of Canada
              and, accordingly, the related financial assets and liabilities
              are subject to fluctuations in exchange rates. The Corporation
              manages its exposure to foreign currency fluctuations by
              maintaining foreign currency bank accounts and receivables to
              offset foreign currency payables and planned expenditures.

              Fluctuations in interest rates could result in a significant
              change in the amount the Corporation pays to service variable
              interest US dollar-denominated debt. World oil prices are
              quoted in US dollars and the price received is also affected by
              the Canadian/US dollar exchange rate that may fluctuate over
              time. Variations in the exchange rate of the Canadian dollar
              could have a significant positive or negative impact. To the
              extent that the Corporation engages in risk management
              activities related to foreign exchange rates, it will be
              subject to credit risk associated with counterparties with
              which it contracts. No derivative contracts were entered into
              during 2006, nor outstanding at year-end, to mitigate these
              risks. The increase in the exchange rate for the Canadian
              dollar and future Canadian/US exchange rates will impact the
              future value of the Corporation's reserves as determined by
              independent evaluators.

    -------------------------------------------------------------------------
    15. Subsequent Events
    -------------------------------------------------------------------------

        (a)   On October 24, 2006, the Corporation announced it had signed an
              agreement to increase its working interest in the Safed Koh
              Concession from 22.5% to 30%. The US$11.4 million offer to
              purchase the additional 7.5% working interest is with one of
              the Corporation's existing Safed Koh Block partners (a private
              company). On March 2, 2007, having received the requisite
              approvals from relevant Pakistan government agencies, the
              purchase price of US$11.4 million was satisfied by way of
              US$8.55 million in cash and 1,372,846 common shares of Rally
              Energy Corp. The shares are subject to a four month hold, and
              were reserved for issuance in June 2006 at a price of $2.30 per
              share.

        (b)   On March 13, 2007, the Corporation issued 11 million common
              shares at $5.00 per share for gross proceeds of $55 million,
              pursuant to the terms of a prospectus. Agent commissions of
              $2.8 million were paid in relation to common shares
              subscriptions.

    -------------------------------------------------------------------------
    16. Supplementary Cash Flow Information
    -------------------------------------------------------------------------

                                                        2006            2005
                                               ------------------------------
        (a)   Interest paid                    $     695,623   $     968,032
                                               ------------------------------
                                               ------------------------------

        (b)   Taxes paid                       $           -   $           -
                                               ------------------------------
                                               ------------------------------

        (c)   Cash and cash equivalents,
               end of year
                Cash                           $   9,549,396   $     801,639
                Term deposits                      8,194,249               -
                                               ------------------------------
              Cash and cash equivalents        $  17,743,645   $     801,639
                                               ------------------------------
                                               ------------------------------
    





For further information:

For further information: Abby Badwi, President & CEO, Douglas Urch, Vice
President, Finance & CFO, Tel: (403) 538-0000, Fax: (403) 538-3705

Organization Profile

RALLY ENERGY CORP.

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