Talisman's 2006 Profit Tops $2B

Talisman Energy Inc. on Thursday released its 2006 consolidated financial and operating results. The Company expects to file its Annual Information form, Management's Discussion and Analysis and audited financial statements on March 13, 2007.

Cash flow—a non-GAAP measure--increased 2% to a record $4,748 million ($4.35/share), compared to $4,672 million ($4.23/share) a year ago. The Company generated $1,126 million ($1.04/share) in cash flow during the fourth quarter, down from $1,468 million ($1.34/share) a year earlier primarily due to lower natural gas prices in North America.

Net income was a record $2,005 million ($1.84/share), an increase of 28% over the $1,561 million ($1.41/share) reported in 2005. Net income during the fourth quarter was $598 million ($0.55/share), an increase of 12% versus $533 million ($0.48/share) a year ago.

Earnings from continuing operations(1) were $1,583 million ($1.45/share), compared to $1,853 million ($1.68/share) in 2005. During the fourth quarter of 2006, Talisman generated $332 million ($0.31/share) in earnings from continuing operations, versus $552 million ($0.50/share) for the comparable period a year earlier.

Talisman increased production per share by 4.4% . Production averaged 485,000 boe/d up from 470,000 boe/d in 2005. Oil and liquids production was up 5% to 261,634 bbls/d. The increase came predominantly from Southeast Asia (up 16,106 bbls/d). Talisman increased its natural gas production by 2% to 1,342 mmcf/d.

Production in the fourth quarter averaged 486,000 boe/d, a decrease of 6% over the same period in 2005. This is after asset sales, which had an impact of 12,200 boe/d during the quarter. Talisman's North American gas production averaged 942 mmcf/d during the quarter, an increase of 4% over the previous year despite the loss of 23 mmcf/d due to asset sales.

"Financially it was a good year for Talisman with record cash flow and earnings. We continued to progress our major development projects in the North Sea and Southeast Asia. Talisman delivered respectable reserves growth through drilling and revisions and made strong progress on asset sales and share repurchases in 2006, but our results were also affected by rising costs, lower North American natural gas prices and some operational issues," said Dr. Jim Buckee, President and Chief Executive Officer.

"Production was a record 485,000 boe/d, although we came in lower than the initial guidance provided in December 2005. There were a number of contributing factors, including adverse weather conditions, which led to extended turnaround times and delayed tie-ins, as well as several compressor failures and significant increases in procurement lead times. However, I believe we are steadily overcoming our production issues, with production in the fourth quarter coming in close to expectations and 5.5 % higher than the third quarter.

"We still expect production in 2007 of 485,000 boe/d with a confidence range of plus or minus 5%. With share repurchases, we expect to be within our 5 to 10% production per share target growth range this year. This includes the impact of asset sales already closed plus announced sales, the combined impact of which should total about 57,000 boe/d once all sales are completed. Production is expected to average approximately 465,000 boe/d in the first quarter with an expected exit rate for the year of approximately 530,000 boe/d, driven largely by increasing volumes from our Tweedsmuir oil development. Beyond this, we expect significant growth in both 2008 and 2009 as further projects, currently being progressed, come onstream.

"We added 203 mmboe of proved reserves in 2006 at a cost of $3.7 billion, including net acquisitions and divestitures (A&D), but excluding spending on midstream and oil sands. Excluding A&D, proved reserve additions were about the same, at 202 mmboe with capital spending of approximately $4.4 billion. Overall, excluding A&D activities, we replaced 116% of production, 142% of North American natural gas production and 123% of international liquids production. These are high quality oil (no bitumen) and conventional gas reserves and only 15% of our North American reserves are proved undeveloped.

"In North America, we drilled 496 successful natural gas wells last year. Our fourth quarter natural gas production was up 4% year-over-year and, without asset sales, production would have been up by 6%. The Company drilled some prolific wells in the Foothills and Appalachia regions. We set new production records in the Alberta Foothills and in Bigstone/Wild River. We are building an exciting new gas area along the Outer Foothills, having acquired over 260,000 acres in an area where we see 1 to 2 Tcf of unrisked contingent and prospective resources. We also completed the Lynx and Palliser pipelines with Talisman Midstream Operations recently transporting a record 600 mmcf/d.

"The focus again in 2007 will be deeper, prolific natural gas targets. Although we don't expect any growth in our North American gas volumes this year, it is due to non-core asset sales in 2006 and 2007.

"However, with continued drilling success, we expect to grow our North American gas volumes by approximately 5% in 2008.

"In Alaska, we spudded two wells in February and hope to finish drilling a third before the winter drilling season is over. We acquired additional acreage during the year and now hold the rights to approximately one million net acres.

"In the North Sea, the main story continues to be the progress we are making on our 11 development projects, which are expected to contribute sizeable production volumes over the next 36 months. In total, we expect Talisman's North Sea volumes to grow to 230,000-240,000 boe/d in 2009.

"The Tweedsmuir development was 90% complete at year end. First production is expected in late April with full volumes planned for this September once topside modifications to the Piper platform are completed. Peak production is expected at 56,000 boe/d, with Talisman's share forecast to average approximately 45,000 boe/d in 2008.

"Other UK projects include Duart, Enoch, Wood, Blane, Affleck and the Galley field tie-back to our Tartan platform. We are also integrating the recently acquired Auk and Fulmar fields. Auk has over 800 mmbbls of original oil in place and a recovery factor to date of only 18%. In Norway, work is proceeding on the sanctioned Rev and Yme developments.

"In Indonesia, the gas plant expansion at Corridor is being commissioned in preparation for first sales to West Java, which are expected to start by mid-year. We also plan to shoot 3-D seismic on the deep water Pasangkayu Block in preparation for drilling in late 2008 or 2009.

"In Malaysia/Vietnam, the Bunga Tulip development came onstream in the fourth quarter at approximately 4,000 boe/d. We are progressing the Northern Fields development with first liquids production expected in the third quarter of 2008 and ramping up to 40,000 bbls/d by year end (Talisman share 41.44%) . The Song Doc development in Vietnam Block 46/02 was sanctioned in 2006 with first production expected in mid-2008 at 13,500 bbls/d gross (Talisman share 30%).

"In November 2006, we spudded our first exploration well in Block 15-2/01 offshore Vietnam. The discovery well flowed at 14,863 bbls/d and we are currently testing a sidetrack into the adjacent TGT discovery, which spills onto our block. We plan to drill up to three additional exploration wells on the block this year. This has the potential to be a new core producing area for Talisman.

"In Algeria, we are continuing with the Phase 2 expansion of the Greater MLN gas reinjection project. We acquired rights to the prospective El Hamra Block in Tunisia. We drilled two successful offshore exploration wells in Trinidad and Tobago with plans to drill up to seven exploration and development wells in 2007.

"With these ongoing development projects, we expect production in 2009 to be 20-30% above projected 2007 levels. In addition, there is significant upside reserves potential from our high impact exploration program. Our international exploration portfolio, including Alaska and the Northwest Territories, contains approximately 350 prospects and leads with exposure to 5 billion boe of prospective resources, on an unrisked P50 basis, net to Talisman.

"We continue to act to increase shareholder value while maintaining a prudent balance sheet. Last year we increased the dividend by 32%. We split Talisman shares on a three-for-one basis to enhance liquidity. We delivered on our promise to sell a significant amount of non-core assets and repurchase shares. We have bought back almost $1 billion worth of stock in the past 12 months, and depending on the timing of sales proceeds and capital spending requirements, plan additional repurchases in 2007."

Eight Consecutive Years of Record Cash Flow

                                    Three months ended          Year ended
December 31                                          %                   %
                                     2006  2005 Change   2006  2005 Change
Cash flow ($mm) (1)                 1,126 1,468    (23) 4,748 4,672      2
Cash flow ($/share) (1)              1.04  1.34    (22)  4.35  4.23      3
Net income ($mm)                      598   533     12  2,005 1,561     28
Net income ($/share)                 0.55  0.48     15   1.84  1.41     30
Long-term debt ($mm at year-end)                        4,560 4,263

Shares outstanding (mm at year-end)                     1,064 1,099
(1) non-GAAP measure

Cash flow in 2006 was a record $4,748 million on gross sales of $10,030 million. Cash flow per share increased 2.8% to $4.35. Significant increases came from higher oil prices ($1,043 million), increased volumes ($479 million) and hedging gains ($143 million). These gains were offset by lower natural gas prices ($369 million) and the impact of a stronger Canadian dollar on realized prices ($679 million), increased operating costs ($313 million) and lost production due to asset sales ($124 million). Net income for the year totaled $2,005 million, $444 million higher than last year. Significant changes in non-cash items included increased future tax ($421 million), higher depreciation, depletion and amortization ($316 million) and lower stock based compensation ($589 million) expense. Net income for the year included an after tax gain on asset sales of $432 million. Fourth quarter cash flow fell 23%, largely due to a 21% drop in netbacks with North American natural gas netbacks down 44% compared to the fourth quarter of 2005. Net income for the quarter included an after tax gain on asset sales of $285 million. The Company no longer calculates a diluted cash flow per share amount. Since the introduction in mid-2003 of a cash payment feature attached to the outstanding stock options, approximately 97% of options have been exercised using the cash payment feature. Since the diluted per share calculation assumes all options will be exercised for shares, with no adjustment to account for the fact that actual options exercised for cash have resulted in a reduction of cash flow, management feels that the diluted cash flow per share figure is not relevant as the underlying assumptions are not a realistic view of actual or expected results. Talisman uses the successful efforts accounting method. The differences between the full cost and successful efforts methods of accounting make it difficult to compare net income between companies. In periods of growth and high exploration spending, it is likely that net income determined using the full cost method would be higher than net income determined using the more conservative successful efforts method. Cash Flow Below is a reconciliation of cash provided by operating activities calculated in accordance with generally accepted accounting principles (GAAP) to cash flow (which is a non-GAAP measure of financial performance).


($ millions)                           Three months ended       Year ended
                                           2006      2005   2006      2005
December 31,                                    (Restated)       (Restated)
Cash provided by operating activities       988     1,699  4,374     4,871
Changes in non-cash working capital         138      (231)   374      (199)
Cash flow                                 1,126     1,468  4,748     4,672

Earnings from Continuing Operations $1.6 Billion

In order to better illustrate Talisman's operating performance on an internally consistent basis, the Company has calculated an earnings from continuing operations number. This is a non-GAAP measure. This metric adjusts for significant one-time events, as well as other non-operational impacts on earnings such as the mark-to-market effect of changes in share prices on stock based compensation expense and changes to tax rates. This calculation does not reflect differing accounting policies and conventions between companies.


($ millions, except per share amounts)

                                       Three months ended       Year ended
December 31                                2006      2005   2006      2005
Net income                                  598       533  2,005     1,561
 Operating income from
  discontinued operations                    40        70    197       207
 Gain on disposition of
  discontinued operations                   209         -    356         -
Net income from
 discontinued operations                    249        70    553       207

Net income from continuing
 operations                                 349       463  1,452     1,354
 Insurance expenses(1)                        -         -     10         2
 Stock-based compensation
  (tax adjusted) (2)                         65        88     32       447
 Tax effects of unrealized
  foreign exchange gains
  on foreign denominated debt(3)            (51)       (1)   (27)       50
 Tax rate reductions and other(3)           (31)        2    116         -
Earnings from
 continuing operations(4)                   332       552  1,583     1,853
Per share(4)                               0.31      0.50   1.45      1.68

(1) Insurance costs relate to the current liability associated with past
    claims experience that is expected to be billed in future premiums.
(2) Stock-based compensation expense relates to the mark-to-market value of
    the Company's outstanding stock options and cash units at December 31,
    2006. The Company's stock-based compensation expense is based on the
    difference between the Company's share price and its stock options or
    cash units exercise price.
(3) Tax adjustments include the impact of Canadian corporate tax rate
    reductions and a 10% supplemental tax increase in the UK in 2006, as
    well as future taxes relating in part to unrealized foreign exchange
    gains associated with the impact of a stronger Canadian dollar on
    foreign denominated debt.
(4) This is a non-GAAP measure.

Production per share up by 4.4%

                              Three Months Ended               Year  Ended
December 31                2006    2005 % Change     2006    2005 % Change
Oil and liquids
North America            47,054  54,254      (13)  49,846  53,611       (7)
United Kingdom          102,064 120,922      (16) 102,742 107,020       (4)
Scandinavia              32,677  38,996      (16)  32,474  25,696       26
Southeast Asia           51,953  49,111        6   51,582  35,476       45
Other                    20,733  25,902      (20)  21,559  25,488      (15)
Synthetic oil             4,027   2,854       41    3,431   2,693       27
Total oil and liquids   258,508 292,039      (11) 261,634 249,984        5
Natural gas (mmcf/d)

North America               942     907        4      910     915       (1)
United Kingdom              118     138      (14)     126     111       14
Scandinavia                  16      13       23       14       9       56
Southeast Asia              288     286        1      292     284        3
Total natural gas         1,364   1,344        1    1,342   1,319        2
Total mboe/d                486     516       (6)     485     470        3

Production for the year averaged 485,000 boe/d, an increase of 3% over 2005 and Talisman increased production per share by 4.4% . During 2006, the Company announced the sale of non-core assets with total production volumes of approximately 57,000 boe/d net to Talisman. The estimated impact of asset sales on Talisman's reported production volumes was approximately 4,880 boe/d for the year and 12,200 boe/d in the fourth quarter.

Talisman increased its oil and liquids production by 5% over the prior year. North American liquids production decreased, reflecting the Company's ongoing focus on natural gas in North America, declines from existing fields as well as asset sales. Total North Sea volumes increased reflecting the impact of acquired assets in Scandinavia late in 2005. UK volumes fell, largely due to extended platform turnarounds. Liquids production in Southeast Asia increased with a full year of production from the South Angsi field, first production from the start up of the Naga Kecil well in Block PM-314, startup of the Bunga Tulip field in the fourth quarter and assets acquired in late 2005.

Natural gas volumes increased by 2%. North American volumes were down slightly year over year largely reflecting asset sales. Talisman's North Sea gas volumes are largely demand driven (relatively little gas storage in the UK). Increased sales in Indonesia to Singapore Power and Caltex more than offset lower volumes in Malaysia/Vietnam due to an extended maintenance shutdown caused by bad weather and lower natural gas nominations.

Fourth quarter volumes were 486,000 boe/d, a decrease of 6% over the comparable period a year earlier. Fourth quarter liquid volumes fell reflecting asset sales in North America and the UK and an extended shutdown in Trinidad, due to equipment failure, which is now repaired.

Talisman's fourth quarter gas volumes were up largely on the strength of a 4% increase in North America, despite the loss of approximately 23 mmcf/d in the quarter due to asset sales. Positive drilling results and the startup of the Talisman operated Lynx and Palliser Pipelines were the main contributors. UK fourth quarter natural gas sales were down from the prior year due primarily to asset sales.

On December 12, 2006, the Company issued guidance for expected 2007 production volumes. Talisman expects production to average 485,000 boe/d in 2007 with a confidence level of plus or minus 5%. This includes the impact of the 57,000 boe/d of asset sales announced to date (the Brae asset sale is expected to close late in 2007).

116% Production Replacement

Talisman replaced 116% of production through drilling additions and revisions to proved reserves in 2006. Talisman increased its total proved reserves by 2% to 1.67 billion boe. Net of royalties, the Company had 1.37 billion boe of proved reserves (up 4%).

At year-end, Talisman had 5.4 tcf of proved natural gas reserves and 767 mmbbls of proved oil and liquids reserves.

The Company added a record 471 bcf of proved natural gas reserves in North America, replacing 142% of production through drilling and revisions. Internationally, Talisman replaced 123% of liquids production organically.


Proved Reserves
                                         Oil & Natural Gas  Natural
                                                   Liquids      Gas    BOE
                                                   (mmbbls)    (bcf)   (mm)
December 31, 2005                                      736    5,417  1,639
Discoveries, extensions and additions                   80      564    174
Net acquisitions                                        11      (61)     1
Net Revisions and Transfers                             34      (34)    28
Production                                             (94)    (483)  (175)

Total proved
December 31, 2006                                      767    5,403  1,667
Total probable
December 31, 2006                                      544    2,650    986

At year-end, Talisman had a reserves life index of 9.5 years for proved reserves and 15.2 years for proved and probable reserves.

Talisman's proved reserves are comprised of approximately 46% of high quality oil and liquids and 54% natural gas. Approximately 38% of the Company's total proved reserves are in North America with the North Sea accounting for 29% and Southeast Asia for 27%. At year-end, the Company had 986 mmboe of probable reserves, which comprise a large part of Talisman's development inventory.

Exploration and development spending during 2006 totaled $4.4 billion, excluding Syncrude and Midstream expenditures. Net of acquisitions and divestitures, capital spending was $3.7 billion.

Talisman has an internal qualified reserves engineer who evaluates all of the Company's reserves estimates. In addition, approximately 86% of Talisman's proved reserves have been reviewed by outside engineering firms over the past four years.

The reserves replacement ratio of 116% (before acquisitions) was calculated by dividing the sum of changes (revisions of estimates, improved recovery and discoveries) to estimated proved oil and gas reserves during 2006 by the Company's 2006 conventional production



Total Company                          Three months ended       Year ended
December 31                                2006      2005   2006      2005
WTI oil price US$/bbl                     60.17     60.05  66.25    l56.70
NYMEX gas price US$/mmbtu                  6.62     12.85   7.26      8.55

Talisman netback ($/boe)
Sales price                               53.07     64.26  57.45     56.67
Hedging (Loss)/Gain                        0.52     (0.43)  0.37     (0.46)
Royalties                                  7.99     10.56   9.58      9.41
Operating cost                            10.39      9.04   9.98      8.41
Transportation                             1.27      1.26   1.28      1.21
Netback ($/boe) (1)                       33.94     42.97  36.98     37.18
Oil and liquids netback ($/bbl)           39.20     41.96  43.46     40.62
Natural gas netback ($/mcf)                4.67      7.38   4.92      5.56

(1) Netbacks do not include synthetic oil and pipeline operations.
    Additional netback information by major product type and region is
    contained elsewhere in this news release.

Talisman's realized oil and gas equivalent netback decreased by 0.5% to average $36.98/boe in 2006. Sales prices averaged $57.45/boe, an increase of 1%, reflecting an increase in world oil prices and Talisman's international natural gas prices, offset largely by the drop in North American natural gas prices. Although most oil and natural gas sales are priced off US dollar denominated benchmarks, Talisman reports its netbacks in Canadian dollars. The Canadian dollar strengthened 6% against its US counterpart in 2006. This had an adverse effect on Talisman's reported netbacks.

Royalty rates were unchanged at 17% in 2006.

Unit operating costs averaged $9.98/boe, an increase of 19% over the previous year. The increase is due to a change in Talisman's production mix as well as increased spending on maintenance, extended turnarounds and higher power costs.

Talisman reported a small hedging gain, although the Company remained relatively unhedged throughout the year.

Liquidity and Capital Resources

Talisman's long-term debt at year end was $4.6 billion ($4.5 billion net of cash), up from $4.3 billion at the end of last year. During 2006, the Company generated $4.4 billion of cash provided by operating activities and spent $4.6 billion on exploration and development (including midstream and Syncrude) and received proceeds from net asset sales of $668 million. The Company repurchased approximately 35 million common shares during 2006 and an additional 15.5 million shares subsequent to year end at a total cost of $958 million. In March 2006, the Company renewed its Normal Course Issuer Bid (NCIB) to permit the purchase of up to 54,940,200 common shares, representing 5% of the total common shares outstanding at that time. In December 2006, Talisman amended the current NCIB to the maximum permitted by the TSX, being 10% of the public float on March 22, 2006 (109,767,000 common shares). The NCIB expires in March 2007 and the Company has received Board of Directors' approval to renew the NCIB for another year.

Two common share dividends were paid in 2006 for a total of $163 million (an aggregate of $0.15/share) . The Company's dividend is determined semi-annually by the Board of Directors. At year-end, there were 1,064 million common shares outstanding, down from 1,099 million at December 31, 2005.

At the end of 2006, Talisman's trailing debt to cash flow ratio was 0.96 and debt-to-debt plus equity was 38%.


Capital Spending (1,4)                               2006  % Change   2005
 (millions of dollars)

North America                                       2,420        49  1,623
United Kingdom                                      1,208        38    875
Scandinavia                                           332       129    145
Southeast Asia                                        331         9    305
Other(2)                                              249        35    184
Corporate, IS and Administrative                       36        29     28
                                                    4,576        45  3,160
Acquisitions (3)                                      204       (62)   536
Dispositions                                         (119)      441    (22)
Discontinued operations (5)                          (715)   (1,621)    47
Total                                               3,946         6  3,721

(1) Excludes corporate acquisitions.
(2) Other includes Algeria, Tunisia, Trinidad and Tobago,
    Colombia, Peru, Qatar and Gabon.
(3) Includes the Auk/Fulmar assets acquired in the UK for $181 million in
(4) Includes interest costs that are capitalized on major projects until
    facilities are completed and ready for use.
(5) 2006 includes proceeds on dispositions of $753 million net of capital
    expenditures of $38 million.

During 2006, the Company spent $3 billion on development and $1.5 billion on exploration.

Natural gas continued to be the focus of the Company's capital investment activities in North America, supplemented by low risk oil projects. Of the $2.4 billion of capital spending in North America, $1.1 billion related to exploration activities and development accounted for $1.3 billion. The Company's North America drilling program had a 98% success rate, drilling 496 successful gas wells and 194 oil wells. Exploration and development spending was concentrated in the predominantly gas producing core areas in the Alberta Foothills, Greater Arch, Deep Basin, Monkman/BC Foothills, Edson and Appalachia regions.

Total capital spending in the UK was $1.2 billion, including $138 million for exploration and $1.1 billion for development. Major areas of activity included the ongoing development of the Tweedsmuir, Blane, Wood, Enoch and Affleck projects and drilling and recompletion activity within the Orion, Tartan and Claymore fields. A total of 24 successful development wells were drilled in 2006, in addition to six exploration wells.

In Scandinavia, total expenditures were $332 million and included $102 million on exploration and $230 million on development. In addition to project development costs at Rev of $27 million, five successful development wells were drilled during 2006, in addition to two exploration wells.

Malaysia/Vietnam accounted for $241 million of the $331 million of total capital spending in Southeast Asia with the ongoing development of the Northern Fields in PM-3 CAA. Talisman participated in nine successful development wells in Malaysia/Vietnam during 2006 and one successful exploration well. A total of $76 million was spent in Indonesia, primarily on the Suban Phase 2 development to supply natural gas to West Java in 2007. A total of 19 successful development wells and two successful exploration wells were drilled in Indonesia.

Capital spending in Other included $74 million in North Africa with Talisman participating in 13 successful exploration and development wells in Algeria and two wells in Tunisia. In Trinidad and Tobago, a total of $84 million was spent, primarily on Block 2c development drilling and the Eastern Block onshore exploration activity. A total of four development wells and four exploration wells were drilled in Trinidad and Tobago. During 2006, the Company spent $91 million in the rest of the world, including $22 million in Qatar on exploration drilling.


Additional Information

Unit Depreciation, Depletion and Amortization Expense
(includes accretion of ARO)

($/boe)                                              2006  % Change   2005

North America                                       14.18        13  12.57
United Kingdom                                      12.60        14  11.07
Scandinavia                                         19.78        19  16.65
Southeast Asia                                       6.17        28   4.83
Other                                                9.17        (2)  9.37
                                                    12.26        13  10.81

Total Depreciation, Depletion and Amortization Expense
(includes accretion of ARO)

(millions of dollars)                                           2006  2005

North America                                                  1,024   908
United Kingdom                                                   440   397
Scandinavia                                                      248   157
Southeast Asia                                                   224   144
Other                                                             69    83
                                                               2,005 1,689

The Company's 2006 DD&A expense increased $316 million, or 19%, to $2 billion, with a per unit rate of $12.26/boe ($10.81/boe in 2005) due primarily to recently acquired assets and high levels of capital spending. DD&A rates in North America increased to $14.18/boe, primarily due to higher drilling costs, increased capital expenditures on infrastructure projects as well as increased land amortization costs. In North America, total DD&A expense increased 13% to $1,024 million. In the UK, total expense increased 11% to $440 million, as DD&A rates increased 14% to $12.60/boe, but were partially offset by a 3% reduction in boe production.

In Scandinavia, total expense increased by $91 million to $248 million, as DD&A rates increased 19% to $19.78/boe, combined with a 28% increase in boe production. Total DD&A expense for Southeast Asia increased by $80 million, or 56%, to $224 million due to the impact of a 28% increase in the rate to $6.17/boe and a 21% increase in boe production. Total Other DD&A expense decreased by 17% to $69 million, primarily as a result of a decrease in production, as the rate decreased 2% to $9.17/boe.


Dry Hole Expense

(millions of dollars)                                          2006   2005

North America                                                   135    122
United Kingdom                                                   26     38
Scandinavia                                                      11     15
Southeast Asia                                                   15     11
Other (1)                                                       109     55
                                                                296    241
(1) In 2006, Other includes Trinidad and Tobago, Colombia, Qatar, Peru and

During 2006, the Company incurred dry hole expense of $296 million, $55 million higher than last year. In North America, dry hole expense was $135 million. In the UK, a total of three wells were expensed for a total of $26 million. The Company also wrote off one well in Scandinavia, two wells in Southeast Asia and seven wells in the rest of the world.


Exploration Expense

(millions of dollars)                                          2006   2005

North America                                                   168    143
United Kingdom                                                   25     29
Scandinavia                                                      30     24
Southeast Asia                                                   22     40
Other                                                            73     39
                                                                318    275

Exploration expense consists of geological and geophysical costs, seismic, land lease rentals and indirect exploration expenses. These costs are expensed as incurred under the successful efforts method of accounting. The majority of the $43 million increase to $318 million relates to increased exploration activity in North America and other potential growth areas.


Corporate and Other

(millions of dollars)                                          2006   2005

G&A expense                                                     233    201
Interest expense                                                166    163
Capitalized interest                                             72     19
Stock-based compensation                                         51    633
Other revenue                                                   119    112
Other expense                                                   (29)    39

General and administrative (G&A) expense increased due to additional personnel, salary increases and higher administrative costs. On a unit basis, G&A was $1.31/boe (2005 - $1.17/boe; 2004 - $1.14/boe) . The sum of interest on long-term debt and capitalized interest was $238 million during 2006, up from $182 million in 2005 on higher debt levels in the current year. Interest capitalized in 2006 is primarily associated with the Tweedsmuir development project in the UK, which is scheduled to come on production early in the second quarter of 2007. In addition, interest costs of $18 million in 2006, $3 million in 2005 and nil in 2004, have been allocated to discontinued operations.

Other revenue includes pipeline and custom treating revenues of $103 million for 2006, compared to $88 million for 2005. Other expense during 2006 included the gain on sale of a royalty interest in an undeveloped lease of $108 million, partially offset by foreign exchange losses of $24 million and costs related to the Beatrice Wind Farm of $22 million.

Stock-Based Compensation

Stock-based compensation expense relates to the appreciated value of the Company's outstanding stock options and cash units at December 31, 2006. The Company's stock-based compensation expense is based on the difference between the Company's share price and its stock options, or cash units exercise price. A total of $51 million was expensed in 2006. The Company paid cash of $159 million ($153 million in 2005) to employees in settlement of fully accrued option liabilities for options exercised. Comparatively, during 2005 the 90% increase in the Company's share price resulted in an expense of $633 million. Over the course of 2006, the average exercise price of all outstanding options increased from $8.71 per share to $10.79 per share, with a total of 63.9 million options outstanding at December 31, 2006.

The Company's stock option plans provide employees and directors who hold stock options with the choice upon exercise to purchase a share of the Company at the stated exercise price or to receive a cash payment in exchange for surrendering the option. The cash payment is equal to the appreciated value of the stock option as determined based on the difference between the option's exercise price and the approximate share price at the time of surrender. The cash payment alternative is expected to result in reduced shareholder dilution in the future as it is anticipated that most holders of the stock options (now and in the future) will elect to take a cash payment. Such cash payments made by the Company to stock option holders are deductible by the Company for income tax purposes, making these plans more cost-effective.

Since the introduction of the cash feature, approximately 97% of options that have been exercised have been exercised for cash, resulting in reduced dilution of shares.

Additional stock-based compensation expense or recoveries in future periods is dependent on the movement of the Company's share price and the number of outstanding options and cash units.

Income Taxes

The Company's effective tax rate for 2006, after deducting Petroleum Revenue Tax (PRT), was 47%, compared to 45% in 2005. A number of events in the past two years have affected the Company's effective tax rates, including tax rate increases in the UK, tax rate reductions in Canada and acquisitions of producing assets in Norway in 2005.


Effective Income Tax Rate

(millions of dollars)                                          2006   2005

Income from continuing operations before tax                  3,046  2,643
Less PRT
 Current                                                        256    147
 Future                                                          34     37
                                                                290    184
                                                              2,756  2,459
Income tax expense/(recovery)
 Current                                                        752    978
 Future                                                         552    127
                                                              1,304  1,105
Effective income tax rate (%)                                    47     45

In 2006, future tax expense increased $425 million to $552 million, as the Company recorded a $325 million charge related to the income tax rate increase on petroleum profits from 40 to 50% in the UK, partially offset by a recovery of future taxes of $178 million related to Canadian federal and provincial tax rate reductions and $34 million in the UK related to the deferral of 2005 capital expenditure claims to 2006 and 2007 for tax purposes.

A normalized effective tax rate after removing the impact of the UK and Canadian tax rate changes and the tax on unrealized foreign exchange gains on foreign denominated debt would have been 44% in 2006 and 43% in 2005. The increase in the 2006 effective tax rate results, in part, from a higher tax rate in the UK. Foreign exchange rate fluctuations over the past several years have resulted in taxes on gains related to inter-company loans and non-C$ denominated debt, for which there is no corresponding component of the unrealized gain reflected in income before taxes.

Current income tax expense decreased to $752 million in 2006, due primarily to higher capital allowances in the UK and lower US charges due to reduced natural gas prices.

The UK government levies PRT on North Sea fields that received development approval before April 1993, based on gross profit after allowable deductions, including capital and operating expenditures. PRT, which is deductible for purposes of calculating corporate income tax, increased as a result of both higher prices and volumes on fields in the UK subject to PRT. In addition to the UK, PRT is levied in Australia and other countries where $66 million and $16 million, respectively, were recorded during 2006.

Talisman Energy Inc. is an independent upstream oil and gas company headquartered in Calgary, Alberta, Canada. Talisman has operations in Canada and its subsidiaries operate in the North Sea, Southeast Asia, Australia, North Africa, the United States and Trinidad and Tobago. Talisman's subsidiaries are also active in a number of other international areas.

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