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New Zealand.

Annual Report 2006


AUSTRALIA

NEW ZEALAND

Tasman Sea

North Island

Taranaki Basin Oil and Gas Permits Permit 38153 Permit 38157 Permit 38732 Permit 38736 Permit 38738 S Permit 38738 D Permit 38741 Permit 38744 Permit 38745 Permit 38746 Permit 38748 Permit 38751 Permit 38757 Permit 38758 Permit 38765 Permit 38766 Permit 38767

• •• • • •• • • • • • •• • • • • •

• • •

East Coast Basin Oil and Gas Permits Permit 38341 Permit 38342

Canterbury Basin Oil and Gas Permits Permit 38256 Permit 38258 Permit 38260 South Pacific

South Island


Letter

from

the President

Dear Stockholder, Fiscal year 2006 was an exciting and challenging year for energy investors, providing TAG Oil with the opportunity to transform itself into one of the leading energy explorers in New Zealand. The industry has entered another consolidation phase, with operators worldwide requiring critical mass to secure services from a drilling and completion industry facing continuously increasing demands on its services. To address this challenge, TAG has worked aggressively to ensure that it will be a consolidator, raising significant capital in North America, acquiring the assets of five competitors in New Zealand during FY 2006, and acquiring another three companies subsequent to year end. Quietly Taking Control of Onshore Exploration in Taranaki TAG’s balance sheet was enhanced substantially by the closing of private placements in North America in FY 2006 and FY 2007. As part of these financings, TAG welcomes a large group of institutional investors who strengthen the Company’s credibility and industry recognition, and our new capital position allows us to pursue and complete acquisition opportunities and accelerate the exploration program. FY 2006 was TAG’s busiest operational year to date. We drilled a number of exploration wells and made our first hydrocarbon discoveries—SuppleJack-1 and SuppleJack South-1A. We hope to commercialize these in FY 2007 by drilling additional wells in this gas/condensate-rich area. Our team was also busy with a number of seismic programs. In Taranaki we completed a 2-D project in previously unexplored PEP 38758, which has provided a drillready prospect (Mangamingi-1) scheduled for fall. In onshore Canterbury, 2-D seismic conducted over our exciting Kate prospect on PEP 38260 has confirmed previous indications that this large surface anticline studded with oil seeps continues at depth. A rig is contracted to test this closure later in 2006. A 2-D program was also completed on PEP 38256 over our Salmon prospect. Data confirmed closure over this previously undrilled prospect, allowing TAG to prepare for an exploration well in 2007. Finally, TAG Oil acquired two large permits of almost a million acres in the East Coast Wairarapa Basin, after participating in the first modern seismic data ever shot here. Adjacent to the proven Taranaki Basin, this undrilled area has numerous oil and gas seeps within the permit. Right on Target TAG Oil has continued on the path of consolidation in FY 2007. The acquisition of Cheal Petroleum and two associated companies in June 2006 has added long-life oil reserves; the approval of the Cheal Oil Pool Development Plan is scheduled to bring over 1000 bbls/day on-stream by January 2007 to the Joint Venture, providing TAG with strong cash flow. We have a significant interest in over five million acres of exploration lands, and we’re positioned with an impressive portfolio of high-impact, drill-ready prospects in New Zealand, a country that provides a politically low-risk, fiscally attractive backdrop for exploration growth. The Company is capitalized to drill continuously for the next two years as we continue to pursue exciting new opportunities. TAG’s long term plan will continue to focus on risk management, while our newly acquired exploration opportunities position us to “beat the odds.” FY 2006 has opened the door for TAG to become “The Onshore New Zealand Exploration Company.” I want to particularly welcome our many new shareholders, and thank all of our shareholders for supporting our vision. We look forward to reporting our successes to you in the coming year and beyond. Sincerely,

Drew Cadenhead President

1 Annual Report 2006


Letter

from

the Auditor

To the Shareholders of TAG Oil Ltd., We have audited the consolidated balance sheets of TAG Oil Ltd. as at March 31, 2006 and 2005 and the consolidated statements of operations and deficit and cash flows for each of the years in the three-year period ended March 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards (“GAAS”) in Canada and the standards of the Public Company Accounting Oversight Board (“PCAOB”) (United States). Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at March 31, 2006 and 2005 and the results of its operations and its cash flows for each of the years in the three-year period ended March 31, 2006, in accordance with generally accepted accounting principles in Canada.

De Visser Gray Chartered Accountants Vancouver, British Columbia Canada July 7, 2006

Comments by Auditors for U.S. Readers on Canada–U.S. Reporting Differences In the United States, reporting standards for auditors require the addition of an explanatory paragraph (following the opinion paragraph) when the financial statements are affected by significant uncertainties and contingencies such as those referred to in note 1 to these financial statements. Although we conducted our audits in accordance with both Canadian GAAS and the standards of the PCAOB, our report to the shareholders dated July 7, 2006 is expressed in accordance with Canadian reporting standards, which do not require a reference to such matters when the uncertainties are adequately disclosed in the financial statements.

De Visser Gray Chartered Accountants Vancouver, British Columbia Canada July 7, 2006

2 Annual Report 2006


Consolidated Balance Sheets (Expressed in Canadian Dollars)

As at March 31,

2006

2005

ASSETS Current Cash and cash equivalents Amounts receivable and prepaids Inventory (Note 2) Marketable securities

$ 18,753,695 376,334 942,769 — 20,072,798 9,155,763 30,836

Oil and gas properties (Note 3) Equipment (Note 4)

L IABILITIES

AND

$

6,368,935 184,344 — 3,300 6,556,579 1,933,088 16,834

$ 29,259,397

$

8,506,501

$

$

546,421

S HAREHOLDERS ’ E QUITY

Current Accounts payable and accrued liabilities

2,229,565 2,229,565

Share capital (Note 5) Contributed surplus Deficit

38,424,949 709,860 (12,104,977)

18,053,464 586,031 (10,679,415)

27,029,832

7,960,080

$ 29,259,397 Nature of operations (Note 1)

Commitments and contingencies (Note 6)

546,421

$

8,506,501

Subsequent events (Note 8)

Approved by the Board of Directors:

Garth Johnson, Director

Drew Cadenhead, Director

See accompanying notes.

3 Annual Report 2006


Consolidated Statements

of

Operations

and

Deficit

(Expressed in Canadian Dollars)

For the Years Ended March 31,

2006

2005

2004

EXPENSES General and administrative Stock option compensation Directors & officers insurance Foreign exchange Amortization

$

Loss before other items

1,404,864 123,829 32,250 (62,080) 7,596

$

(1,506,459)

829,233 185,395 — 212,589 4,512

$

(1,231,729)

650,680 290,030 — 30,787 5,496 (976,993)

OTHER ITEMS Interest income Write-off of oil and gas properties Gain on sale of marketable securities Gain on sale of property and equipment

399,684 (358,699) 39,912 —

Net loss for the year Deficit, beginning of year

17,352 — — —

15,737 (1) — 23,256

(1,425,562) (10,679,415)

(1,214,377) (9,465,038)

(938,001) (8,527,037)

Deficit, end of year

$ (12,104,977)

$ (10,679,415)

$ (9,465,038)

Loss per share

$

$

$

Weighted average number of shares outstanding

(0.04) 37,330,058

(0.09) 13,111,779

(0.08) 11,227,776

See accompanying notes.

4 Annual Report 2006


Consolidated Statements

of

Cash Flows

(Expressed in Canadian Dollars)

For the Years Ended March 31,

2006

2005

2004

OPERATING ACTIVITIES Net loss for the year Changes for non-cash operating items: Amortization Stock option compensation Write-off of oil and gas properties Gain on sale of marketable securities Gain on sale of property and equipment

$ (1,425,562)

$ (1,214,377)

7,596 123,829 358,699 (39,912) —

$

4,512 185,395 — — —

(938,001) 5,496 290,030 1 — (23,256)

(975,350)

(1,024,470)

(665,730)

(191,990) — (942,769) 71,261

(143,649) (9,960) — 66,485

89,967 (71,632) — (13,260)

(2,038,848)

(1,111,594)

(660,655)

Issuance of common shares Repurchase of common shares

20,371,485 —

7,437,513 (7,338)

149,150 —

Cash provided by financing activities

20,371,485

7,430,175

149,150

Changes for non-cash working capital accounts: Amounts receivable and prepaids Due to/from related parties Inventory Accounts payable and accrued liabilities Cash used in operating activities

FINANCING ACTIVITIES

I NVESTING ACTIVITIES Exploration of oil and gas properties Proceeds from sale of property and equipment Purchase of property and equipment Proceeds from sale of marketable securities

(5,969,491) — (21,598) 43,212

(822,236) — (3,876) —

(124,169) 404,141 (3,268) —

Cash (used in) provided by investing activities

(5,947,877)

(826,112)

276,704

Net increase (decrease) in cash during the year Cash and cash equivalents—Beginning of year

12,384,760 6,368,935

5,492,469 876,466

Cash and cash equivalents—End of year

$ 18,753,695

$ 6,368,935

$

876,466

Cash Cash equivalents

$

2,515,613 16,208,082

$ 6,368,935 —

$

271,319 605,147

$ 18,753,695

$ 6,368,935

$

876,466

$

$

$

15,737

Supplementary disclosures: Interest received

399,684

17,352

(234,801) 1,111,267

Non-cash investing activities: The Company incurred $2,077,526 (2005: $465,643 and 2004: $Nil) in exploration expenditures which amounts were in accounts payable at year end.

See accompanying notes.

5 Annual Report 2006


Notes

to the

Consolidated Financial Statements

For the Years Ended March 31, 2006 and 2005 (Expressed in Canadian Dollars) NOTE 1—Nature of Operations

The Company was incorporated under the Business Corporations Act (British Columbia) and continued its jurisdiction of incorporation to the Yukon Territory under the Business Corporations Act (Yukon). Its major activity is the acquisition and exploration of international oil and gas properties. The Company is in the process of exploring its oil and gas properties and has not yet determined whether they contain reserves that are economically recoverable. The success of the Company’s exploration and development of its oil and gas properties is influenced by significant financial and legal risks, as well as commodity prices and the ability of the Company to discover economically recoverable reserves and to bring such reserves into future profitable production. In addition, the Company must continue to obtain sufficient financing to develop its properties towards planned principal operations. NOTE 2—Summary of Significant Accounting Policies

a) Accounting Principles and Use of Estimates These financial statements are prepared in accordance with Canadian generally accepted accounting principles (“GAAP”), which require the Company’s management to make informed judgments and estimates that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the fiscal year. Specific items particularly subject to management estimates are the carrying amounts of deferred property costs, potential accruals for future site reclamation costs and the determination of inputs required in the calculation of stock based compensation. Actual results could differ from these estimates. Material differences between Canadian and United States generally accepted accounting principles, which that the Company, are described in note 9. b) Basis of Consolidation These consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries: TAG Oil (NZ) Limited, TAG Oil (Canterbury) Limited, and Durum Energy (PNG) Limited. The Company consolidates its financial statements with those of its subsidiaries in which it has a controlling interest. Should restrictions be placed on any foreign subsidiary that prevent the Company from exercising effective control, the Company’s investment in that subsidiary shall be accounted for using the cost basis. All significant intercompany balances and transactions with subsidiaries have been eliminated on consolidation. c) Joint Operations Substantially all of the Company’s activities relate to the exploration for oil and gas. To the extent that these activities are conducted jointly with other companies, the accounts reflect only the Company’s proportionate interest in these activities. d) Translation of Foreign Currencies The Company’s foreign operations, conducted through its subsidiaries, are of an integrated nature and, accordingly, the temporal method of foreign currency translation is used for conversion of foreign-denominated amounts into Canadian dollars. Monetary assets and liabilities are translated into Canadian dollars at the rates prevailing on the balance sheet date. Other assets and liabilities are translated into Canadian dollars at the rates prevailing on the transaction dates. Revenues and expenses arising from foreign currency transactions are translated into Canadian dollars at the average rate for the year. Exchange gains and losses are recorded as income or expense in the year in which they occur. e) Fair Value of Financial Instruments The Company’s financial instruments consist of current assets and current liabilities. The fair values of the current assets and liabilities approximate the carrying amounts due to the short-term nature of these instruments. f) Cash and Cash Equivalents Cash and cash equivalents include term investments with maturities of one year or less, together with accrued interest thereon, which are readily convertible to known amounts of cash. g) Oil and Gas Properties The Company follows the full cost method of accounting for oil and gas properties whereby all costs relating to the acquisition, exploration, and development of oil and gas properties and equipment are capitalized in cost centres by country. Such costs include lease acquisition costs, geological and geophysical expenditures, lease rentals, seismic and costs of drilling productive and non-productive wells, together with overhead expenses related to acquisition, exploration and development

6 Annual Report 2006


activities. All cost centres are in the pre-development stage and as such are not subject to depletion. An assessment is performed at every reporting date to determine whether the aggregate net costs in each pre-development stage cost centre are recoverable. Costs which are unlikely to be recovered are written-off. The recovery of the costs incurred to date is ultimately dependent on discovering commercial quantities of hydrocarbons. The likelihood of such a discovery is not determinable at this time. h) Equipment Furniture, office and computer equipment is recorded at cost less accumulated amortization. Amortization is provided for over its estimated useful life on a declining-balance basis at rates between 20% and 30%. i) Income Taxes The Company accounts for and measures future tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment or substantive enactment of the change. When the future realization of income tax assets does not meet the test of being more likely to occur than not to occur, a valuation allowance in the amount of potential future benefit is taken and no asset is recognized. Such an allowance would apply fully to all potential income tax assets of the Company. The Company’s accounting policy for future income taxes currently has no effect on the financial statements of any of the fiscal years presented. j) Share Capital Common shares issued for non-monetary consideration are recorded at their fair market value based upon the lower of the trading price of the Company’s shares on the TSX Venture Exchange on the date of the agreement to issue shares and the date of share issuance. k) Stock-Option Compensation The Company has a stock based compensation program for officers, directors, employees and consultants. The Company 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 and expensed in the year of grant with a corresponding increase in contributed surplus. Consideration paid upon the exercise of the stock options will be recorded as an increase to share capital together with the corresponding amounts previously recognized in contributed surplus. l) Loss per Share Loss per share is calculated using the weighted-average number of common shares outstanding during the year. Diluted loss per share is not presented, as it is anti-dilutive. m) Marketable Securities The Company’s marketable securities are recorded at the lower of cost and estimated fair market value. n) Asset Retirement Obligation Effective March 31, 2003, the Company has adopted retroactively the Canadian Institute of Chartered Accountants’ new standard on Asset Retirement Obligations. The Company recognizes the fair value of an Asset Retirement Obligation (“ARO”) in the period in which it is incurred when a reasonable estimate of the fair value can be made. The fair value is determined through a review of engineering studies, industry guidelines and managements estimate on a site-by-site basis. The fair value of the ARO is recorded as a liability, with a corresponding increase in the amount of the related asset. The capitalized amount is depleted on the unit-of-production method based on proven reserves. The liability amount of accretion is expensed in the period. Actual costs incurred upon the settlement of the ARO are charged against the liability. At March 31, 2006 the Company does not have any asset retirement obligations. o) Inventory Inventory is valued at the lower of cost and net realizable value with cost being determined using a specific identification basis. Inventory consists of field operation consumables.

7 Annual Report 2006


NOTE 3—Oil and Gas Properties

Working Interest % Unproved: New Zealand: PMP 38153 PMP 38157 PEP 38256 PEP 38258 PEP 38260 PEP 38341 PEP 38342 PEP 38480 PEP 38732 PEP 38736 PEP 38741 PEP 38744 PEP 38745 PEP 38746 PEP 38748 PEP 38751 PEP 38757 PEP 38758 PEP 38765 PEP 38766 PEP 38767 AMI-Hursthouse Total Unproved

15.00 33.33 53.84 25.00 30.00 35.50 35.50 25.00 100.00 15.00 45.00 25.00 83.33 16.67 33.33 66.66 100.00 100.00 38.30 33.33 100.00 12.50

Net Book Value at March 31, 2005

$

— — 166,974 59,833 — — — 86,582 — — 622,042 — — — — — 532,030 3,041 206,866 — — 255,720

$ 1,933,088

Additions During the Period

$

9,597 4,342 250,594 19,334 512,885 523,150 502,635 12,903 1,000 29,843 1,015,849 — 554,925 95,538 — 563,522 1,934,631 980,609 483,289 — 83,234 3,494

$ 7,581,374

Write-offs During the Period

$

—— — — — — — — (99,485) — — — — — — — — — — — — — (259,214)

$ (358,699)

Net Book Value at March 31, 2006

$

9,597 4,342 417,568 79,167 512,885 523,150 502,635 — 1,000 29,843 1,637,891 — 554,925 95,538 — 563,522 2,466,661 983,650 690,155 — 83,234 —

$ 9,155,763

The Company’s oil and gas properties are located in New Zealand and its interests in these properties are maintained pursuant to the terms of exploration permits granted by the national government. The Company is satisfied that evidence supporting the current validity of these permits is adequate and acceptable by prevailing industry standards in respect to the current stage of exploration on these properties. The Company participated in three unsuccessful exploration wells and three exploration wells that are under evaluation to determine if they are commercially viable in combination with future successful wells, all of which are located in onshore Taranaki, New Zealand. The unsuccessful wells drilled during the 2006 fiscal year are: the Richmond-1 well on PEP 38745, the Konini-1 well on PEP 38751 and the Arakamu-1 well in PEP 38757. The wells under evaluation to determine commerciality are: the SuppleJack-1 well on PEP 38741 and the SuppleJack South-1 and SuppleJack South-1a wells on PEP 38765. During the 2006 fiscal year the Company wrote-off PEP 38480 as this permit was relinquished after negotiations with the Ministry of Economic Development in New Zealand did not result in amended exploration terms for the permit. In addition the Company wrote-off the costs related to the Hursthouse-1 well as it was determined that the costs associated with this well were unlikely to be recovered in the future. Refer to Notes 6 and 8

8 Annual Report 2006


NOTE 4—Equipment

Equipment is comprised as follows:

Cost Furniture, office and computer equipment

$ 125,644

Accumulated Amortization $ (94,808)

2006

2005

Net Book Value

Net Book Value

$ 30,836

$ 16,834

NOTE 5—Share Capital

a) Authorized and Issued Share Capital The authorized share capital of the Company consists of an unlimited number of common stock without par value. Issued and fully paid:

Number of Shares

Amount

7,978,061

$ 10,623,289

Balance at March 31, 2004 Forward stock split on the basis of one additional new share for every two old shares Private placement Private placement Exercise of share purchase warrants Exercise of stock options Re-purchase of shares and return to treasury

3,989,025 542,495 9,066,500 6,150,000 100,000 (1,800,000)

Balance at March 31, 2005 Exercise of share purchase warrants Private placement

26,026,081 9,066,500 11,538,500

$ 18,053,464 6,395,039 13,976,446

Balance at March 31, 2006

46,631,081

$ 38,424,949

— 1,247,218 4,412,383 1,744,978 32,934 (7,338)

During the 2006 fiscal year, the Company issued 9,066,500 shares from treasury upon the exercise of certain share purchase warrants at a price of US$.60 per share. On September 22, 2005, the Company completed a brokered private placement financing consisting of 11,538,500 shares at a price of $1.30 per share. In connection with this financing, the Company issued 400,000 broker warrants exercisable at a price of $1.30 per share until expiry on September 22, 2006. Refer to Note 8

b) Share Purchase Warrants The following is a continuity of outstanding share purchase warrants: Number of Share Purchase Warrants

Weighted Average Exercise Price(1)

Balance at March 31, 2004 Issued during the year Exercised

6,150,000 9,608,995 (6,150,000)

$ 0.27 0.71 0.27

Balance at March 31, 2005 Exercised Issued during the year

9,608,995 (9,066,500) 400,000

0.71 0.70 1.30

Balance at March 31, 2006

942,495

$ 1.09

(1) Certain share purchase warrants are denominated in US dollars and have been converted to Canadian dollars using the March 31, 2006 closing exchange rate.

9 Annual Report 2006


At March 31, 2006, the following share purchase warrants are outstanding: Number of Shares 542,495 400,000

Price per Share US$0.80 $1.30

Expiry Date May 4, 2006(2) September 22, 2006

942,495 (2) Subsequently, the warrants expired unexercised.

c) Incentive Stock Options At the Company’s annual general meeting held on September 9, 2005, shareholders approved an amendment to the Company’s stock option plan. Under the new stock option plan the number of shares reserved for issuance as share incentive options will be equal to 10% of the Company’s issued and outstanding shares at any time. The exercise price of each option equals the market price of the Company’s shares the day prior to the date that the grant occurs less any applicable discount approved by the Board of Directors and the TSX Venture Exchange. The options maximum term is five years and must vest over a minimum of eighteen months. The following is a continuity of outstanding stock options: Number of Options

Weighted Average Exercise Price(1)

Balance at March 31, 2004 Granted during the year Exercised Cancelled/Expired

1,140,000 550,000 (100,000) (800,000)

$ 0.72 0.76 0.32 0.76

Balance at March 31, 2005 Cancelled/Expired Granted during the year

790,000 (165,000) 400,000

$ 0.76 0.76 0.95

Balance at March 31, 2006

1,025,000

$ 0.83

(1) Certain outstanding options are denominated in US dollars and have been converted to Canadian dollars using the March 31, 2006 closing exchange rate.

At March 31, 2006, the following stock options are outstanding: Number of Shares 100,000 125,000 400,000 75,000 25,000 150,000 150,000

Price per Share

Expiry Date

US$0.65 US$0.65 US$0.65 US$0.65 US$0.95 $1.30 $0.66

May 31, 2008 February 10, 2010 January 1, 2010 May 10, 2010 July 29, 2010 November 22, 2010 January 2, 2011

1,025,000 During the 2006 fiscal year, the Company granted options to three directors and one employee to purchase 400,000 common shares vesting over eighteen months with expiry dates ranging from May 10, 2010 to January 2, 2011 and exercisable at either US$0.65, US$0.95, CDN$0.66 or CDN$1.30.

10 Annual Report 2006


During the 2005 fiscal year, the Company granted options to two directors and to its President to purchase 125,000 common shares vesting over eighteen months with an expiry date of February 10, 2010 and an aggregate of 400,000 common shares vesting over five years with an expiry date of January 1, 2010, respectively, exercisable at a price of US$0.65. The Company also granted an option to a consultant to purchase 25,000 common shares vesting over three years, exercisable at a price of US$0.65 until expiry on May 31, 2008. During the current fiscal year, the Company applied the Black-Scholes option pricing model using the closing market prices on the grant dates, a volatility ratio of 42% and the risk free interest rate of 3.5% to calculate an option benefit at the dates of grant of $0.31 per option share granted (2005: $0.35 per option share granted) for a total option benefit of $123,829 (2005: $185,395). Refer to Note 8

NOTE 6—Commitments and Contingencies

The Company participates in oil and gas exploration operations jointly with independent third and related parties and is contractually committed under agreements to complete certain exploration programs. The Company’s management estimates that the total commitments for fiscal 2006 under various agreements relating to permits held at March 31, 2006 are as follows:

Oil and Gas Property PMP 38153 PMP 38157 PEP 38256 PEP 38258 PEP 38260 PEP 38341 PEP 38342 PEP 38732 PEP 38736 PEP 38741 PEP 38744 PEP 38745 PEP 38746 PEP 38748 PEP 38751 PEP 38757 PEP 38758 PEP 38765 PEP 38766 PEP 38767 Total

Working Interest % 15.00 33.33 53.84 25.00 30.00 35.50 35.50 100.00 15.00 45.00 25.00 83.33 16.67 33.33 66.66 100.00 100.00 38.30 33.33 100.00

Work Commitment or Obligation to March 31, 2006 $

10,500 3,500,000 35,000 175,000 1,400,000 10,500 10,500 17,500 10,500 572,000 40,000 17,500 12,000 17,500 21,000 35,000 1,540,000 193,000 23,000 17,500

$ 7,658,000

Refer to Note 8

11 Annual Report 2006


NOTE 7—Income Taxes

2006 Net loss for the year

$ (1,404,898)

$ (1,214,377)

(498,763) (32,553) 531,316

(431,386) 67,533 363,853

Expected income recovery Net adjustment for amortization, deductible and non-deductible amounts Unrecognized benefit of current non-capital loss Total income taxes

2005

$

$

A reconciliation of income taxes at statutory rates and the significant components of the Company’s future income tax assets are as follows: 2006 Future income tax assets: Net mineral property carrying amounts (in excess) of tax pools Equipment tax pool in excess of carrying value Non-capital loss carryforwards

$

$

11,915,789 (11,915,789)

Valuation allowance Net future tax assets

(5,220,591) 93,876 17,042,504

2005

$

2,144,990 93,954 8,565,636 10,804,580 (10,804,580)

$

The Company has non-capital losses of approximately $3.3 million (2005—$2.32 million), which are available to reduce future taxable income in Canada, which expire between 2007 and 2016. Subject to certain restrictions the Company also has mineral property expenditures of approximately $4.1 million (2005—$4.2 million) available to reduce taxable income in future years. The Company has not recognized any future benefit for these tax losses and resource deductions, as it is not considered likely that they will be utilized. At March 31, 2006, the Company also has losses and deductions of approximately NZ$16.9 million (March 31, 2005— NZ$8.0 million) available to offset future taxable income earned in New Zealand. NOTE 8—Subsequent Events

During the period subsequent to March 31, 2006 the following occurred: a) Acquisition of Cheal Petroleum, PEP 38757 Limited and PEP 38758 Limited On June 16, 2006, the Company acquired all of the outstanding shares of Cheal Petroleum Limited (“Cheal”), PEP 38757 Limited and PEP 38758 Limited all located in New Zealand. Cheal owns a 30.5% interest in PEP 38738-S containing the Cheal Oil Field and a 15.1% interest in PEP 38738-D containing the Cardiff deep gas prospect. Consideration paid for these three companies was NZ$18,542,857 (CDN$12,800,000), five million shares of the Company and a 0.775% gross over riding royalty on PEP 38738-D. The work commitments expected over the 2007 fiscal year for PEP 38738-S and PEP 38738-D amount to a total of $6,000,000 and relate materially to the Cheal Oil Field Development plan. b) Private placement financing On June 12, 2006, the Company completed a private placement financing of 40,000,000 common shares at a price of $0.75 per share for net proceeds of approximately $28.1 million. c) Stock options On April 25, 2006 the Company granted an employee an option to acquire up to 100,000 common shares, vesting over eighteen months, exercisable at a price of $0.90 per share until expiry on April 25, 2011.

12 Annual Report 2006


NOTE 9—Differences between Canadian and United States Generally Accepted Accounting Principles

These financial statements have been prepared in accordance with Canadian generally accepted accounting principles (“Canadian GAAP”) which conform in all material respects with United States generally accepted accounting principles (“U.S. GAAP”), except for the following differences: Consolidated Balance Sheets

a) Assets i) Marketable Securities Under Canadian GAAP, marketable equity securities are valued at the lower of cost or market value. Under U.S. GAAP, the Company’s marketable equity securities are classified as available-for-sale securities and reported at market value, with unrealized gains and losses included as a component of comprehensive income. March 31, 2006

March 31, 2005

Marketable securities under Canadian GAAP Adjustment required under U.S. GAAP Cumulative historical adjustments

$ — — —

$

3,300 10,200 16,800

Marketable securities under U.S. GAAP

$ —

$ 30,300

As a result, total current assets under U.S. GAAP as at March 31, 2006 and 2005 would be $20,072,798 and $6,583,579, respectively. ii) Oil and Gas Property Under U.S. GAAP, the ceiling test under the full cost method is performed for each cost center by comparing the net capitalized costs to the present value of the estimated future net revenues from production of proved reserves discounted by 10%, net of the effects of future costs to develop and produce the proved reserves, plus the costs of unproved properties net of impairment, and less the effects of income taxes. Any excess capitalized costs are written off to expense. The ceiling test under U.S. GAAP has been limited to those periods in which U.S. GAAP balances have been provided. Under U.S. GAAP, the functional currency for each of the Company’s foreign subsidiaries is the local currency of each subsidiary. Accordingly, the current rate method of foreign currency translation is required to be used for conversion into Canadian dollars. All assets and liabilities are translated into Canadian dollars at the rates prevailing on the balance sheet date. Stockholders’ equity accounts are translated into Canadian dollars at the rates prevailing on the transaction dates, with revenues and expenses translated into Canadian dollars at the average rate for the year. Translation adjustments resulting from foreign currency translations are recorded as a separate component of the stockholders’ equity section on the balance sheet. March 31, 2006

March 31, 2005

Oil and gas properties under Canadian GAAP Foreign currency translation adjustment Cumulative historical adjustments

$ 9,155,763 (1,258,323) 85,529

$ 1,933,088 (7,487) 93,016

Oil and gas properties under U.S. GAAP

$ 7,982,969

$ 2,018,617

As a result of the adjustments, total assets under U.S. GAAP as at March 31, 2006 and 2005 would be $28,086,603 and $8,619,030, respectively.

13 Annual Report 2006


b) Stockholders’ Equity i) Common Stock During the 2004 fiscal year, the Company began recording, under Canadian GAAP, the cost of stock options granted to employees and consultants utilizing a fair value measurement basis, a policy that is materially consistent with U.S. GAAP for stock-based compensation as described in Statement of Accounting Standards 123 (“SFAS 123”). However, in previous fiscal years, prior to the adoption of the fair value measurement standard under Canadian GAAP, the Company was subject to the minimum disclosure standards of SFAS 123 under U.S. GAAP, which required it to report, on a pro-forma basis, the effect of following a fair value based method of measuring the value of stock options granted using the Black Scholes, or similar, option pricing model. In accordance with the mandatory disclosure standard, the following are the pro-forma figures for common stock had the Company used, from inception, a fair value-based method of accounting for stock based compensation as described in SFAS 123: March 31, 2006

March 31, 2005

Common stock under Canadian GAAP Cumulative historical adjustments

$ 38,424,949 3,042,858

$ 18,053,464 3,042,858

Common stock under U.S. GAAP

$ 41,467,807

$ 21,096,322

March 31, 2006

March 31, 2005

ii) Foreign Currency Translation Adjustment The effects of Note 9(a)(ii) on foreign currency translation adjustment are as follows:

Foreign currency translation adjustment under Canadian GAAP Foreign currency translation adjustment Cumulative historical adjustments

$

— (1,258,323) 85,529

Foreign currency translation adjustment under U.S. GAAP

$ (1,172,794)

$

— (7,487) 93,016

$ 85,529

iii) Accumulated Other Comprehensive Income The effects of Note 9(a) on accumulated other comprehensive income are as follows: March 31, 2006

March 31, 2005

Accumulated other comprehensive income under Canadian GAAP Unrealized gain(loss) on marketable securities Cumulative historical adjustments

$

$

Accumulated other comprehensive income under U.S. GAAP

$

— (27,000) 27,000 —

— 10,200 16,800

$ 27,000

As a result of these adjustments, total stockholders’ equity under U.S. GAAP as at March 31, 2006 and 2005 would be $25,857,038 and $8,072,609, respectively.

14 Annual Report 2006


Consolidated Statements of Operations and Deficit

c) Net Loss and Comprehensive Income for the Year The following are the effects of Note 9(a)(i) on net loss for the 2006, 2005, and 2004 fiscal years: 2006 Net loss for the year under Canadian and U.S GAAP Other comprehensive income: Realized gain on marketable securities Portion included previously in comprehensive income Unrealized gain on marketable securities

$ (1,425,562)

Comprehensive loss for the year under U.S. GAAP

$ (1,412,650)

39,912 (27,000) —

2005 $ (1,214,377) — — 10,200 $ (1,204,177)

2004 $ (938,001) — — 13,200 $ (924,801)

15 Annual Report 2006


Notes

16 Annual Report 2006


Corporate Information

Directors and Officers Drew Cadenhead President, CEO and Director New Plymouth, New Zealand Garth Johnson Secretary, CFO and Director Vancouver, British Columbia Paul Infuso Director Winnipeg, Manitoba James Smith Director Calgary, Alberta Corporate Office 1050 Burrard Street, Suite 1407 Vancouver, B.C. Canada V6Z 2S3 Phone: 604-609-3350 Fax: 604-682-1174 Operational Office 117 Powderham Street P.O. Box 183 New Plymouth, New Zealand Phone: +64-6-769-6065 Fax: +64-6-769-6075 Technical Headquarters Braemar Building 32 The Terrace, 4th Floor PO Box 3058 Wellington, New Zealand Shareholder Relations Phone: 604-609-3350 Email: ir@tagoil.com Subsidiaries TAG Oil (NZ) Limited TAG Oil (Canterbury) Limited Cheal Petroleum Limited

Share Capital At August 26, 2006, there were 91,631,081 shares issued and outstanding. Fully diluted: 93,156,081 shares. Banker Bank of Montreal Vancouver, British Columbia Legal Counsel Blake, Cassels & Graydon, LLP Vancouver, B.C. Chapman Tripp Wellington, New Zealand Auditors De Visser Gray Chartered Accountants Vancouver, British Columbia Registrar and Transfer Agent Computershare Trust Company of Canada 100 University Avenue, 9th Floor Toronto, Ontario Canada M5J 2Y1 Phone: 1-888-661-5566 Fax: 1-604-661-9480 Annual General Meeting The Annual General Meeting will be held on September 22, 2006 at 10:00 a.m. at the offices of Blake, Cassels and Graydon, located at Suite 2600, Three Bentall Centre, 595 Burrard Street, Vancouver, B.C. Share Listing TSX Venture Exchange Trading Symbol: TAO OTCBB Trading Symbol: TAGOF Website www.tagoil.com

Annual Report 2006


CORPORATE OFFICE TAG Oil Ltd. 1050 Burrard Street Suite 1407 Vancouver, B.C. Canada V6Z 2S3 Phone: 604-609-3350 Fax: 604-682-1174 OPERATIONAL OFFICE TAG Oil (NZ) Limited 117 Powderham Street P.O. Box 183 New Plymouth, New Zealand Phone: +64-6-769-6065 Fax: +64-6-769-6075 TECHNICAL HEADQUARTERS Braemar Building 32 The Terrace, 4th Floor PO Box 3058 Wellington, New Zealand www.tagoil.com


MANAGEMENT’S DISCUSSION AND ANALYSIS The following Management’s Discussion and Analysis (MD&A) of operations and financial conditions is dated July 27, 2006, for the period ended March 31, 2006 and should be read in conjunction with the Company’s accompanying audited consolidated financial statements and the accompanying notes for the years ended March 31, 2006 and 2005. Forward Looking Statements Certain disclosure in this MD&A contains forward-looking statements that involve risk and uncertainties. Such information, although considered reasonable by the Company at the time of preparation, may prove to be incorrect and actual results may differ materially from those anticipated in the statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Such risks and uncertainties include, but are not limited to, risks associated with operations, loss of market, regulatory matters, commodity price risk, environmental risks, industry competition, uncertainties as to the availability and cost of financing, risks in conducting foreign operations, potential delays or changes in plans with respect to exploration or capital expenditures. Additional information relating to the Company can be found at www.sedar.com. Business TAG Oil Ltd. is an independent Canadian oil and gas exploration company with international operations in the Taranaki, East Coast and Canterbury Basins of New Zealand. As of the date of this report, TAG holds interests in seventeen petroleum permits in the commercially proven Taranaki Basin, two interests in the East Coast Basin and three interests in the Canterbury Basin. Taranaki is a lightly explored area with a good discovery rate and the Company’s interests in Taranaki cover 81,097 net acres. In addition, the Company’s two interests in the East Coast Basin and three interests in the Canterbury Basin cover 310,360 acres and 1.47 million net acres, respectively in the noncommercialized, but proven prospectives for oil and gas discovery. Petroleum Property Activities and Capital Expenditures for the year ended March 31, 2006 During the year ended March 31, 2006 the Company incurred $7,581,374 worth of expenditures on its oil and gas exploration properties compared to $1,287,879 of expenditures last year. At March 31, 2006 the Company also held drilling and casing inventory at a cost of $942,769 for future drilling operations. The primary capital expenditures during the year were as follows: PEP 38741 (45%): $1,015,849 of expenditures were made during the year relating to the costs of drilling, completing and testing the Supplejack-1 well on this permit. Supplejack-1 encountered two potential hydocarbon zones and, to date, the lower gas zone has been tested and flowed at a maximum rate of 640,000 cubic feet per day with the joint venture incorporating the short-term flow testing results into the Kaimata 3-D data to consider its options to maximize the development potential of this discovery. The SuppleJack-1 well is currently suspended pending the outcome of the Ratanui-1 well scheduled for the second half of the 2007 fiscal year. PEP 38745 (83.33%): $554,925 of expenditures were made during the year primarily relating to the drilling of the Richmond-1 well. This well was drilled in October 2005 and although the main objective sandstones were encountered and a number of thick reservoir sands were penetrated, electrical logs indicated the reservoir was not likely to produce commercial quantities of hydrocarbons and the well was plugged and abandonded. PEP 38751 (66.66%): $563,522 of expenditures were made during the year relating to the drilling of the Konini-1 well in November of 2005. Konini-1 reached the target sandstones and after evaluating the well data the well was plugged and abandoned. PEP 38757 (100%): $1,934,631 of expenditures were made this year relating mainly to the the costs of drilling the Arakamu-1 well. Arakamu-1 was drilled in January 2006 and encountered good quality oil and gas shows but did not find significant reservoir zones so the well was plugged and abandoned. TAG Oil Ltd. www.tagoil.com Corporate Office 1407-1050 Burrard St. Vancouver, BC V6Z 2S3 Canada ph 604-609-3350 fx 604-682-1174

PEP 38758 (100%): $980,609 of expenditures were incurred this year to conduct the Company’s 35 kilometer 2-D seismic program. This program was completed in January 2006 data resulting in processed data that is of excellent quality and the Company expects to drill a well on the permit based on this data in late 2006.


PEP 38765 (38.30%): $483,289 of expenditures were made during the year relating to the drilling, completion and testing of the SuppleJack South-1 and the SuppleJack South-1a wells between November 2005 and February of 2006. Both wells penetrated high quality sands with SuppleJack South 1a yielding gas utilising under-balanced perforation techniquies. Both wells are currently suspended awaiting the outcome of the Ratanui-1 well scheduled for the second half of 2007 in the neighbouring permit, PEP 38741. PEP 38256 (53.84%): $250,594 of expenditures were made during the year relating to a 30 kilometer 2-D seismic program recently completed that identified a closure over the Company’s Salmon prospect. This seismic information is being incorporated with other permit data in order to determine an optimal drilling location for late 2007. PEP 38260 (70.00%): $512,885 of expenditures were made during the year relating to the two seismic programs carried out during the year to acquire 27 kilometer’s of 2-D seismic that have confirmed the existence of a large rollover structure at depth in the Kate prospect that is expected to be drilled in November 2006. PEP 38341 and PEP 38342 (35.50%): $1,025,785 of expenditures were made during the year relating to the Company’s participation in a 67 kilometer seismic program carried out over both permits during the year. The Company has the following commitments for Capital Expenditure at March 31, 2006: Contractual Obligations Long term debt Operating leases Purchase obligations Other long-term obligations (1) Total Contractual Obligations (2)

Total $ 7,658,000 7,658,000

Less than One Year $ 7,658,000 7,658,000

More than One Year $ -

(1) The Other Long Term Obligations that the Company has are in respect to the Company’s share of expected exploration permit obligations and/or commitments. (2) The Company’s total commitments include those that are required to be incurred to maintain the permit in good standing during the current permit term, prior to the Company committing to the next stage of the permit term where additional expenditures would be required. In addition costs are also included that relate to commitments the Company has made that are in addition to what is required to maintain the permit in good standing. The Company’s commitments shown above totalling $7,658,000 include certain exploration activities that exceed the required exploration work required under the permit terms to maintain the permits in good standing and are subject to change as exploration work is completed and results are received. The material commitment amounts include: PMP 38157 (33.33%): $3,500,000 is currently committed to the drilling of the Radnor 1a well in July and August, 2006 twith TAG paying 66.66% of the costs of the well to earn a 33.33% interest in the permit and the Radnor production station. The Radnor 1a well will whipstock out of the original Radnor-1 wellbore and target the McKee sands at a depth of approximately 4,100m. PEP 38741 (45%): $572,000 is currently committed to the drilling of a shallow well (Ratanui-1) on this permit in the second quarter of the 2007 fiscal year well as some minor costs associated with the permit. PEP 38758 (100%): $1,540,000 is committed to the exploration efforts on this permit consisting substantially of costs relating to drilling the Magamingi-1 well in the second or third quarter of the 2007 fiscal year. PEP 38260 (70%): $1,400,000 is committed to drilling the Kate-1 well in this permit in November 2006. The Kate-1 well will be the first exploration well over the Kate anticline prospect. In addition to the above, we will continue our geological and geophysical work on the balance of our permits and, where warranted, and when rig availability permits, we intend to drill additional wells during the year. Acquisitions affecting commitments for capital expenditures, subsequent to March 31, 2006: Subsequent to March 31, 2006 the Company acquired three New Zealand oil and gas Companies, Cheal Petroleum Ltd., PEP 38757 Ltd. and PEP 38758 Ltd. Cheal Petroleum Ltd. holds a 30.5% interest in the Cheal Oil Field (PEP 38738-S) and a 15.1% interest in the Cardiff deep gas prospect (PEP 38738-D), both situated on PEP 38738 in New Zealand. The capital expenditures relating to this acquisition over the next year are approximately $6mm and relate essentially to the approved development plan for the Cheal Oil Field where the Company expects to drill 2 development


wells and 2 exploration wells . Please refer to Note 8 of the the accompanying audited consolidated financial statements for additional information. Selected Annual Financial Information The following table summarizes selected annual information for the years ended March 31, 2006, 2005 and 2004.

Production revenue Net loss Net loss per share Working capital Total assets Long term debt Shareholders equity

$

$

2006 (1,425,562) (0.04) 17,843,233 29,259,397 27,029,832

$

$

2005 (1,214,377) (0.09) 6,010,158 8,506,501 7,960,080

$

$

2004 (938,001) (0.08) 896,208 1,583,140 1,558,887

Results of Operations The Company incurred a net loss for the 2006 fiscal year of $1,425,562 ($0.04 per share) compared to $1,214,377 ($0.09 per share) for the 2005 fiscal year. The Company’s revenue for the 2006 fiscal year consisted entirely of interest of $399,684 and a gain on sale of mareketable securities of $39,912 compared to $17,352 of interest income last year. The increase in interest income was a result of the Company’s increased working capital from financing’s completed during the year. General and administrative (“G&A”) costs increased to $1,404,864 in 2006 from $829,233 in 2005 (a 69% increase) due to the Company’s increased activity levels related to the Company’s assets and, to a lesser extent, costs associated with successfully listing on the TSX Venture exchange. The main items contributing to the increased G&A were wages and travel costs. Wages accounted for 45% of the increase mainly because the Company employed a full-time exploration manager at the start of the fiscal year, the Company paid bonuses to the Company’s executives in December of 2005 and annual rates of compensation increased for the Company’s executives during the year. At the end of the 2006 fiscal year the Company also added a full time chief geophysicist to manage the increase in the Company’s exploration permits in New Zealand from seven permits in fiscal 2005 to twenty two by the date of this report. Travel costs accounted for 25% of the increase as these costs include costs associated with the Company’s President relocating to New Zealand as well as travel costs relating to the Company’s acquisition, exploration and financing efforts. A comparative summary of the Company’s G&A costs for the two-years ending March 31, 2006 is as follows:

Consulting fees Directors fees Filing, listing and transfer agent Exploration and reports Office and Administration Professional fees Rent Shareholder relations and communications Travel Wages

$

$

2006 42,896 22,500 117,549 3,693 131,028 121,270 40,280 130,485 240,501 554,662 1,404,864

$

$

2005 3,000 82,093 31,556 65,278 88,880 39,109 130,232 93,486 295,599 829,233

In addition to the above, the Company recorded stock option compensation costs of $123,829 (2005: $185,395) relating to stock options granted during the year and wrote-off $358,699 (2005: Nil) in costs associated with two permits, the details of which are available for review in Note 5 and Note 3 of the accompanying audited consolidated financial statements, respectively.


Summary of Quarterly Results Q4 $ Total Revenue General and administrative Foreign Exchange Stock option compensation Other Net loss Basic loss per share

2006 Q2 $

Q3 $

Q1 $

-

-

(443,804)

(402,270)

292,651

(5,562)

(292,895)

-

(91,500)

(89,676)

144,315

(240,829)

(355,017)

(0.01)

(0.01)

Q4 $

-

Q3 $

2005 Q2 $

Q1 $

-

-

-

-

-

(284,300) (274,490)

(326,217)

(175,313)

(211,095)

(116,608)

67,886

(59,228)

(56,994)

(21,467)

(74,900)

(12,355)

(19,974)

(185,395)

-

-

-

(38,330)

24,742

3,970

962

4,255

3,653

(627,880) (201,836)

(566,870)

(231,345)

(228,307)

(187,855)

(0.04)

(0.02)

(0.02)

(0.02)

(0.02)

(0.01)

Liquidity and Capital Resources The Company began the 2006 fiscal year with 26,026,081 common shares issued and outstanding and during the year ended March 31, 2006 the Company issued 20,605,000 shares through a private placement and through the exercise of share purchase warrants for total proceeds of $20,371,485. The Company ended the year with $18,753,695 (March 31, 2005: $6,368,935) in cash and cash equivalents, $17,843,233 (March 31, 2005: $6,010,158) in working capital and with 46,631,081 shares issued and outstanding. Subsequent to year-end the Company issued 40,000,000 common shares to raise net proceeds of approximately $28,100,000. Please refer to Note 8 of the accompanying audited consolidated financial statements for more information realting to the Company’s activities subsequent to year end. Off-Balance Sheet Arrangements and Proposed Transactions The Company has no off-balance sheet arrangements or proposed transactions. Disclosure controls and procedures The Company maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed in filings made pursuant to Multilateral Instrument 52-109 is recorded, processed, summarized and reported within the time periods specified by securities regulations and that information required to be disclosed is accumulated and communicated to Management. The Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures and have concluded that they are adequate and effective to ensure accurrate and complete disclosure. Business Risks and Uncertainties The Company, like all companies in the international oil and gas sector, is exposed to a variety of risks which include the uncertainty of finding and acquiring reserves, funding and developing those reserves and finding markets for them. In addition there are commodity price fluctuations, interest and exchange rate changes and changes in government regulations. The oil and gas industry is intensely competitive and the Company must compete against companies that have larger technical and financial resources. The Company works to mitigate these risks by evaluating opportunities for acceptable funding, considering farm-out opportunities that are available to the Company, operating in politically stable countries, aligning itself with joint venture partners with significant international experience and by employing highly skilled personnel. The Company also maintains a corporate insurance program consistent with industry practice to protect against losses due to accidental destruction of assets, well blowouts and other operating accidents and disruptions. The oil and gas industry is subject to extensive and varying environmental regulations imposed by governments relating to the protection of the environment and the Company is committed to operate safely and in an envoironmentally sensitive manner in all operations. Additional information relating to the Company is available on www.sedar.com.


http://www.tagoil.com/pdf/TAG_AR_2006