SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2006

Commission File No. 000-22750

ROYALE ENERGY, INC.

(Exact name of registrant as specified in its charter)

California

33-0224120

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

7676 Hazard Center Drive, Suite 1500

San Diego, CA 92108

(Address of principal executive offices)

(Zip Code)

619-881-2800

(Registrant's telephone number, including area code)

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

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

Large accelerated filer  [   ]

Accelerated filer  [   ]

Non-accelerated filer  [X]

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

At September 30, 2006, a total of 7,916,408 shares of registrant's common stock were outstanding.

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

Item 1

Financial Statements

1

Item 2

Management's Discussion and Analysis of Financial Condition and
Results of Operations

8

Item 3

Quantitative and Qualitative Disclosures About Market Risk

11

Item 4

Controls and Procedures

11

PART II

OTHER INFORMATION

Item 1A

Risk Factors

11

Item 6

Exhibits

11

Signatures

12

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PART I     FINANCIAL INFORMATION

Item 1   Financial Statements

ROYALE ENERGY, INC.

BALANCE SHEETS

Nine Months ended

September 30,

2006

2005

Beginning balance at January 1

$                 0 

$                0 

Additions to capitalized exploratory well costs pending the
     determination of proved reserves

1,819,133 

2,276,495 

Reclassifications to wells, facilities, and equipment based on
     the determination of proved reserves

  (1,819,133)

(2,276,495)

Ending balance at September 30

$                 0 

$                0 

Note 5 - Stock Based Compensation

In December 2004, the FASB issued SFAS No. 123R which requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. The FASB concluded that companies can adopt the new standard in one of two ways: the modified prospective transition method, or the modified retrospective transition method. We adopted SFAS No. 123R during the first quarter of fiscal 2006 and use the modified prospective transition method.

On June 1, 2005, Royale Energy awarded shares of restricted common stock to certain of its employees pursuant to an incentive compensation plan. On that date, the Company's stock price was $5.66 per share. A total of 6,048 and 4,612 shares of vested restricted common stock were issued in 2005 and 2006 respectively. The Company recognized corresponding compensation expense of $34,241 and $26,104 for 2005 and 2006. A remaining 7,490 shares of unvested stock were awarded with a vesting date in 2007 for which compensation expense will be similarly recognized.

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Item 2   Management's Discussion And Analysis Of Financial Condition And Results Of Operations

Results of Operations

For the first nine months of 2006, we had a net loss of $71,093 compared to a net profit of $343,822 during the first nine months of 2005. This decrease is primarily attributed to lower natural gas production along with a lower price per Mcf during the period in 2006. We had a net loss of $767,137 for the third quarter of 2006 compared to a 2005 third quarter net profit of $211,584. This was also as a result of lower natural gas production and price per Mcf, as well as a decrease in turnkey drilling revenues. Total revenues for the nine month period in 2006 were $16,622,226, a decrease of $1,439,940 or 8.0% from the total revenues of $18,062,166 during the same period in 2005. Total revenues for the third quarter of 2006 of $4,630,815 decreased $1,819,001 or 28.2% from the third quarter 2005 revenues of $6,449,816.

In the first nine months of 2006, revenues from oil and gas production decreased by $1,245,794 or 16.7% to $6,219,887 from the 2005 revenues of $7,465,681, due to a decrease in natural gas production and price. In the third quarter 2006, oil and gas revenue decreased $862,793 or 30.8% from the third quarter 2005 of $2,797,765. The net sales volume of natural gas for the nine months ended September 30, 2006, was approximately 838,475 Mcf with an average price of $6.22 per Mcf, versus 1,046,123 Mcf with an average price of $6.62 per Mcf for the first nine months of 2005. This represents a decrease in net sales volume of 207,648 Mcf or 19.9%. For the third quarter of 2006, the average price decreased $1.84 per Mcf and the net sales volume of natural gas decreased 58,429 Mcf, from 328,247 Mcf in the period in 2005 to 269,818 Mcf in 2006. These decreases were partially due to natural gas declines in production from existing wells, third party transportation interruptions and to the lack of new production caused by a delay in bringing some of our successful new wells online. The net sales volume for oil and condensate (natural gas liquids) production was 16,153 barrels with an average price of $62.20 per barrel for the first nine months of 2006, compared to 10,687 barrels at an average price of $49.82 per barrel for the same nine months in 2005. This represents an increase in net sales volume of 5,466 barrels, or 51.2%. For the third quarter of 2006, the average price for oil and condensate increased to $63.73 per barrel, from $56.91 and production increased 945, or 21.4% barrels from the same quarter in 2005.

Oil and natural gas lease operating expenses decreased by $786,355 or 30.5% to $1,796,309 for the first nine months ended September 30, 2006, from $2,582,664 for the same period in 2005. For the third quarter 2006, lease operating expenses decreased $147,129 or 18.8% over the same period in 2005. This decrease was mainly due to lower plugging and workover costs in 2006 when compared to 2005.

For the nine months ended September 30, 2006, turnkey drilling revenues decreased $88,206 or 0.9% to $9,523,901 from $9,612,107 in the same period in 2005. For this period we also had a decrease of $669,224 or 9.7% in turnkey drilling and development costs to $6,222,225 in 2006 from $6,891,449 in 2005. In the third quarter of 2006, turnkey drilling revenues decreased $896,154 or 27.0%, and related drilling and development costs fell $259,663, or 11.0%, over the same quarter in 2005.

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The decreases in turnkey drilling revenues and costs were mainly due a decrease in the number of wells drilled during the period of 2006. We drilled nine wells during the first nine months of 2006 versus thirteen wells during the same period in 2005.

We periodically review our proved properties for impairment on a field-by-field basis and charge impairments of value to expense. Impairment costs of $123,809 were recorded in the first nine months of 2006, an increase of $115,627 or 1413% when compared to the same period in 2005.

Impairment cost for the third quarter 2006 increased $13,482 over the same period in 2005. These impairment costs were mainly due to various lease and land costs that were no longer viable.

The aggregate of supervisory fees and other income was $878,438 for nine months ended September 30, 2006, a decrease of $105,940 or 10.8% from $984,378 during the period in 2005. Third quarter supervisory fees and other income decreased $60,054 or 18.4% to $266,756 from $326,810 in 2005. This reduction was due to the decrease in number of wells drilled and the decrease in natural gas production during the period in 2006.

Depreciation, depletion and amortization expense increased to $2,981,543 from $2,846,820, an increase of $134,723 or 4.7% for the nine months ended September 30, 2006, compared to the same period in 2005. During the third quarter, these expenses decreased $80,309 or 7.3% over the same period in 2005. The depletion rate is calculated using production as a percentage of reserves. This increase in depletion expense was mainly due to the increase in our oil and gas assets due to capitalized drilling costs in 2005 and the nine months of 2006.

General and administrative expenses increased by $119,327 or 3.4%, from $3,506,094 for the nine months ended September 30, 2005, compared to $3,625,421 for the same period in 2006. Third quarter 2006 general and administrative expenses increased $125,890 or 10.2% from $1,230,905 in 2005 compared to $1,356,795 in 2006. This increase was primarily due to a bad debts write-off of approximately $208,577 for receivables from direct working interest investors whose expenses on non-producing wells are contractually not collectable. Legal and accounting expense increased to $300,252 for the nine months ended September 30, 2006, compared to $218,409 for the same period in 2005, a $81,843 or 37.5% increase. For the quarter, legal and accounting expenses increased $35,438 or 54.6% from the previous year. The increase in legal and accounting expense is as a result of higher fees relating to corporate compliance matters and litigation defending property rights. Marketing expense for the nine months ended September 30, 2006, increased $19,801 or 1.7% to $1,197,786 compared to $1,177,985 for the same period in 2005. For the third quarter, marketing expenses decreased $138,062, or 29.5%, to $330,016, compared to $468,078 for the same period in 2005. Marketing expense varies from period to period according to the number of marketing events attended by personnel and their associated costs.

Interest expense increased to $395,476 for the nine months ended September 30, 2006, from $313,538 for the same period in 2005, an $81,938 or 26.1% increase. Interest expense also increased $16,800 or 13.2%, to $144,304 for the third quarter in 2006 when compared to $127,504 in 2005. This increase was due to the higher interest rate on our commercial bank credit line, which increased from 7.25% at September 30, 2005 to 8.75% at September 30, 2006.

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For the first nine months of 2006 our income tax expense decreased to $50,498 from $173,203 during the same period in 2005, a decrease of $122,705, primarily due to the decrease in our net operating income.

Capital Resources and Liquidity

At September 30, 2006, Royale Energy had current assets totaling $10,264,390 and current liabilities totaling $11,990,617, a $1,726,227 working capital deficit. We had cash and cash equivalents at September 30, 2006, of $5,173,677 compared to $4,716,772 at December 31, 2005. During the nine months ended September 30, 2006, we drew approximately $160,000 on our commercial bank credit line and loan.

We have a revolving line of credit under a loan agreement with Guaranty Bank, FSB, which is secured by all of our oil and gas properties. At September 30, 2006, we had outstanding indebtedness of $6,560,000, compared to $6,400,000 at December 31, 2005. Our loan from Guaranty Bank, FSB, secured by our non-oil and gas real estate assets, had outstanding indebtedness of approximately $255,711 on September 30, 2006 compared to $321,344 at December 31, 2005.

At September 30, 2006, our accounts receivable totaled $3,174,107, compared to $4,221,601 at December 31, 2005, a decrease of $1,047,494 or 24.8%, primarily due to a decrease in our oil and gas receivables for the period. At September 30, 2006, our accounts payable and accrued expenses totaled $6,004,350, a decrease of $1,370,811 or 18.6% from the accounts payable at December 31, 2005, of $7,375,161, due to the decrease in our oil and gas revenues payable during the period in 2006.

We ordinarily fund our operations and cash needs from cash flows generated from operations. We believe that we have sufficient liquidity for the remainder of 2006 and do not foresee any liquidity demands that cannot be met from cash flow from operations.

Operating Activities. For the nine months ended September 30, 2006, cash provided by operating activities totaled $2,471,186 compared to $4,667,141 for the same period in 2005, a $2,195,955 or 47.1% decrease. The decrease in cash provided was due to the decrease in oil and gas sales as well as a reduction in the company's accrued liabilities during the period of 2006.

Investing Activities. Net cash used by investing activities, primarily in capital acquisitions of oil and gas properties, amounted to $2,108,648 for the period in 2006, compared to $9,602,390 used by investing activities for the same period in 2005, a $7,493,742 or 78% decrease in cash used. This was primarily due to a decrease in cash used for undeveloped properties and the drilling of fewer wells (nine during the period 2006 and thirteen during the period in 2005), and lower drilling costs per well during the period in 2006.

Financing Activities. For the nine months ended September 30, 2006, cash provided by financing activities was $94,367 compared to $343,738 for the same period in 2005. This decrease was primarily due to the increase in the use of our line of credit in 2005 when compared to 2006.

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Item 3   Quantitative and Qualitative Disclosures About Market Risk

Our major market risk exposure relates to pricing of oil and gas production. The prices we receive for oil and gas are closely related to worldwide market prices for crude oil and local spot
prices paid for natural gas production. Prices have been volatile for the last few years, and we expect that volatility to continue. Monthly average natural gas prices ranged from a low of $5.03 per Mcf to a high of $8.10 per Mcf for the first nine months of 2006. We have not entered into any hedging or derivative agreements to limit our exposure to changes in oil and gas prices or interest rates.

Item 4   Controls and Procedures

As of September 30, 2006, an evaluation was performed under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of September 30, 2006.

No significant changes occurred in our internal control over financial reporting during the quarter ended September 30, 2006.

PART II     OTHER INFORMATION

Item 1A Risk Factors

There were no changes in the risk factors discussed in our Annual Report on Form 10-K during the third quarter of 2006.

Item 6   Exhibits

31.1 Rule 13a-14(a)/15d-14(a) Certification

31.2 Rule 13a-14(a)/15d-14(a) Certification

32.1 18 U.S.C. Section 1350 Certification

32.2 18 U.S.C. Section 1350 Certification

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Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ROYALE ENERGY, INC.

Date:    November 14, 2006

/s/ Donald H. Hosmer   

Donald H. Hosmer, President and Chief Executive Officer

Date:    November 14, 2006

/s/ Stephen M. Hosmer    

Stephen M. Hosmer, Executive Vice President and Chief Financial Officer

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