UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-Q

(Mark  One) [ X ]  QUARTERLY  REPORT  PURSUANT  TO  SECTION  13 OR  15(d) OF THE
SECURITIES  EXCHANGE ACT OF 1934 FOR THE  QUARTERLY  PERIOD ENDED  SEPTEMBER 30,
2006

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION  PERIOD FROM TO COMMISSION  FILE NUMBER:  0-19118
ABRAXAS  PETROLEUM  CORPORATION  (Exact name of  registrant  as specified in its
charter)

        Nevada                                        74-2584033

(State of Incorporation)                   (I.R.S. Employer Identification No.)

             500 N. Loop 1604 East, Suite 100, San Antonio, TX 78232

               (Address of principal executive offices) (Zip Code)
                                  210-490-4788

              (Registrant's telephone number, including area code)

                                 Not Applicable

              (Former name, former address and former fiscal year,
                          if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2)  has  been  subject  to the  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  (as  defined  in  Rule  12b-2  of  the  Exchange  Act)  or a
non-accelerated  filer.  See  definition  of  "accelerated  filer"  and "  large
accelerated filer" in Rule 12b-2 of the Exchange Act.


Large Accelerated Filer [   ] Accelerated Filer  [X]  Non-Accelerated Filer [  ]


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


The  number of shares  outstanding  of each of the  issuer's  classes  of common
stock, as of November 3, 2006.

         Class                                           Shares Outstanding

Common Stock $.01 Par Value                                 42,666,577







Forward-Looking Information

     We make forward-looking  statements throughout this document.  Whenever you
read a statement  that is not simply a  statement  of  historical  fact (such as
statements  including words like "believe",  "expect",  "anticipate",  "intend",
"plan", "seek", "estimate",  "could", "potentially" or similar expressions), you
must  remember  that  these  are   forward-looking   statements   and  that  our
expectations may not be correct, even though we believe they are reasonable. The
forward-looking  information  contained in this document is generally located in
the material set forth under the heading  "Management's  Discussion and Analysis
of  Financial  Condition  and Results of  Operations"  but may be found in other
locations as well.  These  forward-looking  statements  generally  relate to our
plans and objectives for future  operations and are based upon our  management's
reasonable  estimates of future  results or trends.  The factors that may affect
our expectations regarding our operations include, among others, the following:

         o    our high debt level;

         o    our  success  in   development,   exploitation   and   exploration
              activities;

         o    our ability to make planned capital expenditures;

         o    declines in our production of natural gas and crude oil;

         o    prices for natural gas and crude oil;

         o    our  ability  to  raise   equity   capital  or  incur   additional
              indebtedness;

         o    economic and business conditions;

         o    political  and economic  conditions  in oil  producing  countries,
              especially those in the Middle East;

         o    price and availability of alternative fuels;

         o    our restrictive debt covenants;

         o    our acquisition and divestiture activities;

         o    results of our hedging activities; and

         o    other factors discussed elsewhere in this document.


     In addition to these  factors,  important  factors  that could cause actual
results to differ materially from our expectations ("Cautionary Statements") are
disclosed  under "Risk  Factors" in our Annual  Report on Form 10-K for the year
ended  December  31,  2005  which are  incorporated  by  reference  herein.  All
subsequent written and oral  forward-looking  statements  attributable to us, or
persons acting on our behalf,  are expressly  qualified in their entirety by the
Cautionary Statements.


                                       2

                          ABRAXAS PETROLEUM CORPORATION
                                   FORM 10 - Q
                                      INDEX

                                     PART I
                              FINANCIAL INFORMATION




                                                                                                  
ITEM 1 -          Financial Statements
                      Condensed Consolidated Balance Sheets--September 30, 2006
                      and December 31, 2005..............................................................4
                      Condensed Consolidated Statements of Operations -
                           Three and Nine Months Ended September 30, 2006 and 2005.......................6
                      Condensed Consolidated Statements of Cash Flows -
                           Nine Months Ended September 30, 2006 and 2005.................................7
                      Notes to Condensed Consolidated Financial Statements...............................8

ITEM 2 -          Management's Discussion and Analysis of Financial Condition and
                           Results of Operations........................................................13

ITEM 3 -          Quantitative and Qualitative Disclosure about Market Risk.............................27

ITEM 4 -          Controls and Procedures...............................................................28

                                     PART II
                                OTHER INFORMATION

ITEM 1  -         Legal Proceedings.....................................................................29
ITEM 1a -         Risk Factors..........................................................................29
ITEM 2  -         Unregistered Sales of Equity Securities and Use of Proceeds...........................29
ITEM 3  -         Defaults Upon Senior Securities.......................................................29
ITEM 4  -         Submission of Matters to a Vote of Security Holders...................................29
ITEM 5  -         Other Information.....................................................................29
ITEM 6  -         Exhibits..............................................................................29
                  Signatures............................................................................30



                                       3





                          Abraxas Petroleum Corporation
                      Condensed Consolidated Balance Sheets
                                 (in thousands)

                                                                        September 30,
                                                                            2006               December 31,
                                                                         (Unaudited)               2005
                                                                      ------------------     -------------------
Assets:
                                                                                   
Current assets:
   Cash ...................................................       $              1,029   $                 42
   Accounts receivable, net
          Joint owners..........................................                   412                    540
          Oil and gas production................................                 6,325                  7,957
          Other.................................................                    38                    100
                                                                      ------------------     -------------------
                                                                                 6,775                  8,597

  Other current assets..........................................                   576                  1,638
                                                                      ------------------     -------------------
       Total current assets.....................................                 8,380                 10,277

Property and equipment:
  Oil and gas properties, full cost method of accounting:
      Proved....................................................               342,645                333,373
  Other property and equipment..................................                 3,438                  3,289
                                                                      ------------------     -------------------
      Total.....................................................               346,083                336,662
      Less accumulated depreciation, depletion, and
        amortization............................................               242,181                231,414
                                                                      ------------------     -------------------
      Total property and equipment - net........................               103,902                105,248

Deferred financing fees, net ...................................                 4,844                  6,037
Other assets  ..................................................                 1,205                    304
                                                                      ------------------     -------------------
  Total assets..................................................  $            118,331   $            121,866
                                                                      ==================     ===================





         See accompanying notes to condensed consolidated financial statements




                                       4





                          Abraxas Petroleum Corporation
                Condensed Consolidated Balance Sheets (continued)
                                 (in thousands)

                                                                        September 30,
                                                                            2006                 December 31,
                                                                         (Unaudited)                 2005
                                                                     --------------------     -------------------
                                                                                     
Liabilities and Stockholders' Deficit
Current liabilities:
  Accounts payable..............................................  $              1,949     $              9,814
  Oil and gas production payable................................                 2,637                    3,481
  Accrued interest..............................................                 5,527                    1,368
  Other accrued expenses........................................                 1,490                      494
                                                                     --------------------     -------------------
    Total current liabilities...................................                11,603                   15,157

Long-term debt..................................................               126,077                  129,527

Future site restoration.........................................                   986                      883
                                                                     --------------------     -------------------
         Total liabilities......................................               138,666                  145,567

Stockholders' deficit:
  Common Stock, par value $.01 per share-
  Authorized 200,000,000 shares; issued, 42,638,577 and
   42,063,167 ..................................................                   426                      421
  Additional paid-in capital....................................               163,812                  162,795
  Accumulated deficit...........................................              (185,398)                (188,193)
  Treasury stock, at cost, 35,562 and 56,477 shares.............                  (285)                    (408)
  Accumulated other comprehensive loss..........................                 1,110                    1,684
                                                                     --------------------     -------------------
      Total stockholders' deficit...............................               (20,335)                 (23,701)
                                                                     --------------------     -------------------
Total liabilities and stockholders' deficit.....................  $            118,331     $            121,866
                                                                     ====================     ===================








         See accompanying notes to condensed consolidated financial statements




                                       5



                          Abraxas Petroleum Corporation
                      Consolidated Statements of Operations
                                   (Unaudited)

                                                               Three Months Ended              Nine Months Ended
                                                                 September 30,                   September 30,
                                                          -----------------------------  ------------------------------
                                                              2006          2005 (1)          2006         2005 (1)
                                                          --------------  -------------  --------------- --------------
                                                                     (in thousands, except per share data)
                                                                                           
Revenue:
   Oil and gas production revenues.................      $     12,847    $    13,829     $     38,642    $     30,690
   Rig revenues....................................               363            330            1,168             909
   Other...........................................                 6              5               15              14
                                                          -------------- --------------  --------------- --------------
                                                               13,216         14,164           39,825          31,613
Operating costs and expenses:
   Lease operating and production taxes............             2,929          3,007            8,467           7,807
   Depreciation, depletion, and amortization.......             3,631          2,107           10,767           5,622
   Rig operations..................................               178            176              608             560
   General and administrative (including
   stock-based compensation of $207, $16, $578 and              1,052            969            3,474           3,054
   $57)............................................
                                                          -------------- --------------  --------------- --------------
                                                                7,790          6,259           23,316          17,043
                                                          -------------- --------------  --------------- --------------
Operating income ..................................             5,426          7,905           16,509          14,570

Other (income) expense:
   Interest income.................................                (1)           (11)              (2)            (12)
   Interest expense................................             4,440          3,700           12,526          10,241
   Amortization of deferred financing fees.........               398            403            1,193           1,257
   Other expense...................................                 -             30                -             274
                                                          -------------- --------------  --------------- --------------
                                                                4,837          4,122           13,717          11,760
                                                          -------------- --------------  --------------- --------------
Earnings  from continuing operations ................             589          3,783            2,792           2,810

Net income from discontinued operations (net of $6,060
   income tax expense in 2005)..........................            -              -                -          12,894
                                                          -------------- --------------  --------------- --------------
Net earnings ........................................    $        589    $     3,783     $      2,792    $     15,704
                                                          ============== ==============  =============== ==============


Basic earnings per common share:
   Net earnings per common from continuing operations    $       0.01    $      0.09     $       0.07    $       0.07
   Discontinued operations...........................               -              -                -            0.34
                                                          -------------- --------------  --------------- --------------
Net earnings per common share - basic................    $       0.01    $      0.09     $       0.07    $       0.41
                                                          ============== ==============  =============== ==============

Diluted earnings per common share:
   Net earnings per common from continuing operations    $       0.01    $      0.09     $       0.06    $       0.07
Discontinued operations..............................               -              -                -            0.32
                                                          -------------- --------------  --------------- --------------
Net earnings  per common share - diluted.............    $       0.01    $      0.09     $       0.06    $       0.39
                                                          ============== ==============  =============== ==============


1. Reflects retrospective adoption of SFAS 123R.


         See accompanying notes to condensed consolidated financial statements


                                       6






                          Abraxas Petroleum Corporation
                 Condensed Consolidated Statements of Cash Flows
                                   (Unaudited)

                                 (in thousands)

                                                                              Nine Months Ended
                                                                                September 30,
                                                                ----------------------------------------------
                                                                           2006                   2005
                                                                ----------------------      ------------------
                                                                                   
Operating Activities
Net earnings .................................................  $              2,792     $          15,704
Income from discontinued operations...........................                     -               (12,894)
                                                                      ----------------      ------------------
Income from continuing operations.............................                 2,792                 2,810
Adjustments to reconcile net income to net
    cash provided by operating activities:
 Depreciation, depletion, and amortization....................                10,767                 5,622
 Amortization of deferred financing fees......................                 1,193                 1,257
 Accretion of future site restoration.........................                    76                    71
 Stock-based compensation.....................................                   578                    57
 Changes in operating assets and liabilities:
     Accounts receivable......................................                 1,822                (2,774)
     Other ...................................................                  (413)                2,849
     Accounts payable and accrued expenses....................                (3,525)                4,877
                                                                      ----------------      ------------------
Net cash provided by continuing operations....................                13,290                14,769
Net cash (used in) provided by discontinued operations........                     -                (4,132)
                                                                      ----------------      ------------------
Net cash provided by operations                                               13,290                10,637

Investing Activities
Capital expenditures, including purchases and development  of
  properties  ................................................               (21,290)              (28,604)
Proceeds from the sale of oil and gas properties..............                11,869
                                                                      ----------------      ------------------
Net cash used in continuing operations........................                (9,421)              (28,604)
Net cash provided by discontinued operations..................                     -                25,719
                                                                      ----------------      ------------------
Net cash used in investing activities.........................                (9,421)               (2,885)

Financing Activities
Proceeds from long-term borrowings............................                14,850                17,688
Payments on long-term borrowings..............................               (18,300)              (14,271)
Proceeds from issuance of common stock (net)..................                     -                11,275
Issuance of stock for compensation............................                   116                   102
Deferred financing fees ......................................                     -                   (57)
Exercise of stock options  ...................................                   452                   397
                                                                      ----------------      ------------------
Net cash (used in) provided by continuing operations..........                (2,882)               15,134
Net cash used in discontinued operations......................                     -               (23,407)
                                                                      ----------------      ------------------
Net cash used in financing activities.........................                (2,882)               (8,273)
                                                                      ----------------      ------------------
Increase (decrease)in cash....................................                   987                  (521)
Cash, at beginning of period..................................                    42                 1,284
                                                                      ----------------      ------------------
Cash, at end of period........................................     $           1,029     $             763
                                                                      ================      ==================


Supplemental disclosure of cash flow information:
Interest paid.................................................     $           8,291     $           7,635
                                                                      ================      ==================
Non-cash items:
Future site restoration.......................................     $              27     $              29
                                                                      ================      ==================




         See accompanying notes to condensed consolidated financial statements


                                       7




                          Abraxas Petroleum Corporation
              Notes to Condensed Consolidated Financial Statements
                                   (Unaudited)
              (tabular amounts in thousands, except per share data)

Note 1. Basis of Presentation

     The accounting  policies followed by Abraxas Petroleum  Corporation and its
subsidiaries  (the  "Company"  or  "Abraxas")  are set forth in the notes to the
Company's audited  financial  statements in the Annual Report on Form 10-K filed
for the year ended December 31, 2005. Such policies have been continued  without
change.  Also,  refer to the notes to those financial  statements for additional
details of the Company's financial  condition,  results of operations,  and cash
flows. All the material items included in those notes have not changed except as
a result of normal  transactions  in the interim,  or as  disclosed  within this
report. The accompanying interim consolidated financial statements have not been
audited by independent  accountants,  but in the opinion of management,  reflect
all adjustments  necessary for a fair  presentation  of the Company's  financial
position and results of operations.  Any and all adjustments are of a normal and
recurring nature.  The results of operations for the three and nine months ended
September 30, 2006 are not necessarily  indicative of results to be expected for
the full year.

     The consolidated  financial  statements include the accounts of the Company
and its then wholly-owned foreign subsidiary,  Grey Wolf Exploration Inc. ("Grey
Wolf") for the 2005  period.  On  February  28, 2005 Grey Wolf closed an initial
public offering,  resulting in our substantial  divestiture of our capital stock
and  operations  in Grey Wolf.  As a result of the  disposal  of Grey Wolf,  the
results of  operations  of Grey Wolf through  February 28, 2005 are reflected in
our financial statements as discontinued operations.

Stock-based Compensation.

     In December  2004,  the FASB issued SFAS No. 123R,  "Share-Based  Payment".
SFAS No.  123R is a  revision  of SFAS No.  123,  "Accounting  for  Stock  Based
Compensation",  and supersedes APB 25. Among other items,  SFAS 123R  eliminates
the use of APB 25 and the  intrinsic  value method of  accounting,  and requires
companies to recognize  the cost of employee  services  received in exchange for
awards  of equity  instruments,  based on the  grant  date  fair  value of those
awards, in the financial statements.

     The  Company  adopted  SFAS 123R in the  fourth  quarter  of 2005 using the
"modified  retrospective  method".  Under the  "modified  retrospective  method"
entities are permitted to restate financial statements of previous periods based
on proforma disclosures made in accordance with SFAS 123. This standard requires
the cost of all share-based payments, including stock options, to be measured at
fair value on the grant date and recognized in the statement of  operations.  In
accordance  with  this  standard,  all  periods  prior to  January  1, 2005 were
restated  to reflect  the impact of the  standard  as if it had been  adopted on
January 1, 1995, the original  effective date of SFAS No. 123,  "Accounting  for
Stock-Based  Compensation".  Also in accordance  with the standard,  the amounts
that are reported in the  statement of operations  for the restated  periods are
the pro forma amounts previously disclosed under SFAS No. 123.

     The Company  currently  utilizes a standard  option  pricing  model  (i.e.,
Black-Scholes)  to measure the fair value of stock options granted to employees.
While SFAS 123R permits  entities to continue to use such a model,  the standard
also permits the use of a more complex binomial,  or "lattice" model. Based upon
research done by the Company on the alternative models available to value option
grants, and in conjunction with the type and number of stock options expected to
be issued in the future, the Company has determined that it will continue to use
the Black-Scholes model for option valuation as of the current time.

     SFAS 123R includes  several  modifications to the way that income taxes are
recorded in the  financial  statements.  The expense for certain types of option
grants is only  deductible  for tax purposes at the time that the taxable  event
takes place, which could cause variability in the Company's  effective tax rates
recorded  throughout the year.  SFAS 123R does not allow  companies to "predict"
when these  taxable  events will take place.  Furthermore,  it requires that the
benefits associated with the tax deductions in excess of recognized compensation
cost be reported as a financing cash flow, rather than as an operating cash flow


                                       8


as required under current literature. This requirement will reduce net operating
cash flows and increase net financing  cash flows in periods after the effective
date.  These future amounts  cannot be estimated,  because they depend on, among
other things, when employees exercise stock options.

     The following  table  summarizes  the stock option  activities for the nine
months ended September 30, 2006 (in thousands except per share data):



                                                            Weighted           Weighted
                                                            Average            Average
                                                             Option             Grant
                                                            Exercise           Date Fair        Aggregate
                                                            Price Per          Value Per        Intrinsic
                                            Shares             Share             Share            Value
                                        ---------------    --------------     --------------   --------------

                                                                                   
Outstanding December 31, 2005.......           3,016       $     1.75         $      1.27      $     3,837

Granted............................              188       $     5.32         $      3.82              718

Exercised..........................             (575)      $     0.78         $      0.45             (257)

Expired or canceled.................              (3)      $     4.39         $      3.33               (8)
                                        ---------------                                        --------------
Outstanding September 30, 2006......           2,626       $     2.21         $      1.64      $     4,290
                                        ===============                                        ==============



     The  following  table shows the weighted  average  assumptions  used in the
Black Scholes valuation of the fair value of option grants during 2006.


Expected dividend yield......................................     0%

Volatility...................................................     .884

Risk free interest rate......................................     4.81%

Expected life................................................     5.09

Fair value of options granted (in thousands).................  $   718

Weighted average grant date fair value of options granted....  $  3.82


Additional information related to options at September 30, 2006 and December 31,
2005 is as follows:

                                         September 30,            December 31,
                                             2006                     2005
                                  ----------------------    --------------------
Options exercisable.......                2,001,463                2,224,998
                                  ======================    ====================

As of September  30, 2006 there was  approximately  $2.2 million of  unamortized
compensation  expense  related to  outstanding  options that will be  recognized
through the period ended September 30, 2010.


                                       9

Note 2. Discontinued operations

     On February  28,  2005,  Grey Wolf  completed  an IPO  resulting in Abraxas
substantially divesting itself of its investment in Grey Wolf.

     The operations of Grey Wolf, previously reported as a business segment, are
reported  as   discontinued   operations  for  all  periods   presented  in  the
accompanying  financial  statements  and the  operating  results  are  reflected
separately from the results of continuing operations.

     Income from discontinued operations for the period ended September 30, 2005
includes a gain on the  disposal of Grey Wolf of $21.8  million,  less  non-cash
income  tax  of  $6.1  million,  and a  loss  from  operations,  including  debt
retirement costs, of $2.8 million.

Note 3. Income Taxes

     The Company  records  income taxes using the liability  method.  Under this
method,  deferred tax assets and liabilities are determined based on differences
between  financial  reporting  and tax basis of assets and  liabilities  and are
measured  using the  enacted  tax rates and laws that will be in effect when the
differences are expected to reverse.

     For the period ended  September  30, 2006,  there is no current or deferred
income tax expense or benefit  due to losses  and/or  loss  carryforwards  and a
valuation allowance which has been recorded against such benefits.

Note 4. Long-Term Debt



     Long-term debt consisted of the following:
                                                                            September 30,     December 31,
                                                                                2006               2005
                                                                           ----------------  -----------------
                                                                                          
Floating rate senior secured notes due 2009............................      $    125,000       $   125,000
Senior secured revolving credit facility...............................             1,077             4,527
                                                                           ----------------  -----------------
                                                                                  126,077           129,527
Less current maturities ...............................................                 -                 -
                                                                           ----------------  -----------------
                                                                             $    126,077       $   129,527
                                                                           ================  =================


     Floating Rate Senior Secured Notes due 2009. In connection with the October
2004 financial restructuring, Abraxas issued $125 million in aggregate principal
amount of floating rate senior  secured notes due 2009. The notes will mature on
December 1, 2009.  Interest is payable at a per annum floating rate of six-month
LIBOR plus 7.50%.  The interest  rate was 12.82% per annum as of  September  30,
2006.  The interest rate is reset  semi-annually  on each June 1 and December 1.
Interest is payable  semi-annually  in arrears on June 1 and  December 1 of each
year.

     Senior Secured  Revolving  Credit  Facility.  On October 28, 2004,  Abraxas
entered  into an  agreement  for a revolving  credit  facility  having a maximum
commitment of $15 million, which includes a $2.5 million subfacility for letters
of credit.  Availability  under the  revolving  credit  facility is subject to a
borrowing base  consistent  with normal and customary  natural gas and crude oil
lending transactions.

     Outstanding  amounts under the revolving  credit  facility bear interest at
the prime rate announced by Wells Fargo Bank,  National  Association plus 1.00%.
The interest rate was 9.25% per annum as of September 30, 2006.

     Subject to earlier  termination  rights and events of  default,  the stated
maturity date under the revolving credit facility is October 28, 2008.



                                       10



Note 5. Earnings Per Share



     The  following  table  sets  forth the  computation  of basic  and  diluted
earnings per share:

                                                      Three Months Ended September            Nine Months Ended
                                                                  30,                           September 30,
                                                     -------------------------------    -------------------------------
                                                         2006              2005             2006              2005
                                                     -------------     -------------    --------------    -------------
Numerator:
                                                                                           
  Net income  before effect of discontinued
     operations.................................  $           589  $          3,783  $        2,792    $        2,810
  Discontinued operations.......................               -                 -                -            12,894
                                                     -------------     -------------    --------------    -------------
Net earnings  available to common stockholders..              589             3,783           2,792            15,704
                                                     =============     =============    ==============    =============
Denominator:
  Denominator for basic earnings per share -
    Weighted-average shares.....................       42,584,045        40,962,427      42,550,022        38,478,355

  Effect of dilutive securities:
    Stock options and warrants..................        1,326,731         1,870,121       1,494,866         1,662,562
                                                     -------------     -------------    --------------    -------------

  Dilutive potential common shares
Denominator for diluted earnings per share -
    adjusted weighted-average shares and assumed
    Conversions.................................       43,910,776        42,832,548      44,044,888        40,140,917

  Basic earnings (loss) per share:
    Net income (loss) from continuing
     operations ................................  $          0.01  $           0.09  $         0.07    $         0.07
    Discontinued operations.....................               -                 -               -               0.34
                                                     -------------     -------------    --------------    -------------
Net earnings (loss) per common share - basic....  $          0.01  $           0.09  $         0.07    $         0.41
                                                     =============     =============    ==============    =============

  Diluted earnings (loss) per share:
    Net income (loss) from continuing
     operations ................................  $          0.01  $           0.09  $         0.06    $         0.07
    Discontinued operations.....................               -                 -               -               0.32
                                                     -------------     -------------    --------------    -------------
Net earnings (loss) per common share - basic....  $         0.01   $           0.09  $         0.06    $         0.39
                                                     =============     =============    ==============    =============


Note 6. Hedging Program and Derivatives

     On January 1, 2001, the Company adopted SFAS 133 "Accounting for Derivative
Instruments  and  Hedging   Activities"  (SFAS  133)  as  amended  by  SFAS  137
"Accounting for Derivative  Instruments and Hedging Activities - Deferral of the
Effective  Date of FASB 133" and SFAS 138  "Accounting  for  Certain  Derivative
Instruments  and Certain  Hedging  Activities".  Under SFAS 133, all  derivative
instruments  are recorded on the balance sheet at fair value.  If the derivative
does not qualify as a hedge or is not designated as a hedge, the gain or loss on
the  derivative  is  recognized  currently  in  earnings.  To qualify  for hedge
accounting,  the derivative must qualify either as a fair value hedge, cash flow
hedge or foreign  currency hedge. As of September 30, 2006, the derivatives that
the Company had in place were not designated as hedges and, accordingly, changes
in the fair value of the  derivatives are recorded in current period oil and gas
revenue.

     Under  the terms of our  revolving  credit  facility,  we are  required  to
maintain  hedging  positions  on not  less  than  25% nor  more  than 75% of our
projected natural gas and crude oil production for a rolling six month period.

     The following table sets forth the Company's current hedge position:

 Time Period                  Notional Quantities                      Price
--------------------------------------------------------------------------------
November 2006        10,000 MMbtu of production per day           Floor of $6.00
December 2006        10,000 MMbtu of production per day           Floor of $5.50
January 2007         10,000 MMbtu of production per day           Floor of $5.50
February 2007        10,000 MMbtu of production per day           Floor of $5.50
March 2007           10,000 MMbtu of production per day           Floor of $5.00
April 2007           10,000 MMbtu of production per day           Floor of $4.50

                                       11


Note 7. Contingencies - Litigation

     From time to time, the Company is involved in litigation relating to claims
arising out of its operations in the normal course of business. At September 30,
2006,  the Company was not engaged in any legal  proceedings  that are expected,
individually  or in the  aggregate,  to have a  material  adverse  effect on its
operations.

Note 8. 2005 Employee  Long-Term Equity Incentive Plan

     On May 25,  2006,  the  stockholders  of the Company  approved  the Abraxas
Petroleum  Corporation  2005  Employee  Long-Term  Equity  Incentive  Plan.  The
following is a summary of some of the material terms of the 2005 Employee Plan.

     Purpose.  The  purpose  of the 2005  Employee  Plan is to employ and retain
qualified and competent  personnel and promote the growth and success of Abraxas
by aligning the  long-term  interests of Abraxas'  key  employees  with those of
Abraxas'  stockholders  by  providing an  opportunity  to acquire an interest in
Abraxas and by providing both rewards for exceptional  performance and long-term
incentives for future contributions to the success of Abraxas.

     Administration and Eligibility. The 2005 Employee Plan will be administered
by the Compensation Committee of the Board of Directors and authorizes the Board
to  grant  non-qualified  stock  options,   incentive  stock  options  or  issue
restricted stock to those persons who are employees of Abraxas.

     Shares  Reserved and Awards.  The 2005  Employee  Plan  reserves  1,200,000
shares of Abraxas common stock,  subject to adjustment following certain events,
as  discussed  below.  The maximum  annual award for any one employee is 200,000
shares of Abraxas common stock. If options,  as opposed to restricted stock, are
awarded,  the exercise share price shall be no less than 100% of the fair market
value on the date of the award,  unless the employee is awarded  incentive stock
options and at the time of the award,  owns more than 10% of the voting power of
all classes of stock of Abraxas.  Under this  circumstance,  the exercise  share
price  shall be no less  than 110% of the fair  market  value on the date of the
award.  Option  terms  and  vesting  schedules  are  at  the  discretion  of the
Compensation Committee.




                                       12


                          ABRAXAS PETROLEUM CORPORATION

Item 2. Management's  Discussion and Analysis of Financial Condition and Results
of Operation

     Prior to February  2005,  Grey Wolf  Exploration  Inc.  was a  wholly-owned
Canadian  subsidiary of Abraxas.  In February 2005, Grey Wolf, closed an initial
public  offering  resulting in the  divestiture  of a substantial  amount of our
capital stock in Grey Wolf. As a result of the Grey Wolf IPO and the significant
divestiture of our interest in Grey Wolf, the results of operations of Grey Wolf
are reflected in our Financial  Statements and in this document as "Discontinued
Operations"  and our  remaining  operations  are  referred  to in our  Financial
Statements  and in  this  document  as  "Continuing  Operations"  or  "Continued
Operations".   Unless  otherwise  noted,  all  disclosures  are  for  continuing
operations.

     The  following  is a  discussion  of our  financial  condition,  results of
operations,  liquidity and capital resources.  This discussion should be read in
conjunction  with our consolidated  financial  statements and the notes thereto,
included in our Annual Report on Form 10-K filed for the year ended December 31,
2005.

Critical Accounting Policies

     There have been no changes from the Critical  Accounting  Polices described
in our Annual Report on Form 10-K for the year ended December 31, 2005.

General

     We are an independent  energy company  primarily engaged in the development
and production of natural gas and crude oil.  Historically we have grown through
the  acquisition  and  subsequent  development  and  exploitation  of  producing
properties,  principally  through the  redevelopment of old fields utilizing new
technologies  such as modern log analysis and reservoir  modeling  techniques as
well as 3-D  seismic  surveys  and  horizontal  drilling.  As a result  of these
activities,  we believe  that we have a  substantial  inventory  of  development
opportunities,  which  provide a basis for  significant  production  and reserve
increases.   In  addition,  we  intend  to  expand  upon  our  exploitation  and
development activities with complementary exploration projects in our core areas
of operation.

     Our financial results depend upon many factors which  significantly  affect
our results of operations including the following:

         o    the sales prices of natural gas and crude oil;

         o    the level of total sales volumes of natural gas and crude oil;

         o    the availability  of, and our ability to raise additional  capital
              resources and provide liquidity to meet cash flow needs;

         o    the level of and interest rates on borrowings; and

         o    the level and success of exploitation, exploration and development
              activity.

     Commodity  Prices and Hedging  Activities.  Our results of  operations  are
significantly  affected by fluctuations in commodity prices. Price volatility in
the natural gas market has remained  prevalent in the last few years. In January
2001,  our  realized  prices for natural gas and crude oil were at high  levels.
However, over the course of 2001 and the beginning of the first quarter of 2002,
prices again became depressed, primarily due to the economic downturn. Beginning
in March 2002,  commodity  prices began to increase and continued higher through
December 2005. Crude oil prices have continued to remain strong during the first
nine months of 2006 compared to historical  levels;  however  natural gas prices
have weakened significantly from levels during the latter part of 2005 and first
quarter of 2006.  If natural gas prices  continue to weaken,  our cash flow from
operations will be adversely affected.

     The table below illustrates how natural gas prices have fluctuated over the
eight quarters  prior to and including the quarter ended  September 30, 2006 and
contains the average of the last three days of NYMEX traded  contracts price for


                                       13


each  contract  month in the  quarter  and the prices we  realized  during  each
quarter presented, including the impact of our hedging activities.



                  Natural Gas Prices by Quarter (in $ per Mcf)
                                  Quarter Ended
             --------------------------------------------------------------------------------------------
             Dec. 31,   Mar. 31,      June 30,  Sept. 30,    Dec. 31,    Mar. 31,   June 30,    Sept. 30,
               2004      2005           2005      2005         2005       2006        2006        2006
             ---------  ---------  -----------  ----------  ----------  ---------  ----------  ----------
                                                                       
Index        $6.77      $6.30      $   6.80     $   8.21    $  12.85    $   9.18   $   6.89    $   6.53
Realized     $6.14      $5.26      $   6.33     $   8.15    $   9.12    $   6.52   $   5.78    $   5.43


     The NYMEX natural gas price on November 3, 2006 was $7.88 per Mcf.

     The table below  illustrates  how crude oil prices have fluctuated over the
eight quarters  prior to and including the quarter ended  September 30, 2006 and
contains the average of the last three days of NYMEX traded  contracts price for
each contract month in the quarter  presented and the prices we realized  during
each quarter presented, including the impact of our hedging activities.



                   Crude Oil Prices by Quarter (in $ per Bbl)
                                  Quarter Ended
             --------------------------------------------------------------------------------------------
             Dec. 31,   Mar. 31,      June 30,  Sept. 30,    Dec. 31,    Mar. 31,   June 30,    Sept. 30,
               2004      2005           2005      2005         2005       2006        2006        2006
             ---------  ---------  -----------  ----------  ----------  ---------  ----------  ----------
                                                                       
Index        $ 49.46    $ 47.33    $ 51.76      $ 60.26     $ 61.51     $ 61.53    $ 67.38     $ 71.72
Realized     $ 46.81    $ 47.13    $ 49.43      $ 60.24     $ 57.18     $ 59.57    $ 66.09     $ 66.62



     The NYMEX crude oil price on November 3, 2006 was $59.14 per Bbl.

     We seek to reduce our exposure to price  volatility by hedging a portion of
our production through price floors.

     Under  the terms of our  revolving  credit  facility,  we are  required  to
maintain  hedging  positions with respect to not less than 25% nor more than 75%
of our crude oil and natural  gas  production,  on an  equivalent  basis,  for a
rolling six-month period. We currently have the following hedges in place:

 Time Period               Notional Quantities                      Price
------------------------------------------------------------------------------
November 2006      10,000 MMbtu of production per day           Floor of $6.00
December 2006      10,000 MMbtu of production per day           Floor of $5.50
January 2007       10,000 MMbtu of production per day           Floor of $5.50
February 2007      10,000 MMbtu of production per day           Floor of $5.50
March 2007         10,000 MMbtu of production per day           Floor of $5.00
April 2007         10,000 MMbtu of production per day           Floor of $4.50

     At September 30, 2006,  the  aggregate  fair market value of our hedges was
approximately $392,000.

     Production Volumes. Because our proved reserves will decline as natural gas
and crude oil are produced,  unless we acquire additional  properties containing
proved reserves or conduct successful  exploitation,  exploration or development
activities, our reserves and production will decrease. Our ability to acquire or
find additional reserves in the near future will be dependent, in part, upon the
amount  of  available  funds  for  acquisition,  exploration,  exploitation  and
development projects.

     We had capital  expenditures  of $21.3  million in the first nine months of
2006. As a result of the capital spending  limitations  included in our previous
credit  agreement  and our 11 1/2  notes  due  2007  which  were  eliminated  in
connection with our October 2004  refinancing,  we were limited for most of 2004
in our ability to replace existing production and, consequently,  our production
volumes  decreased during 2004 and continued to decrease in the first quarter of
2005.  Beginning in the second quarter of 2005, our production  volumes began to
increase and have  continued to increase  through the first nine months of 2006.


                                       14


If crude  oil and  natural  gas  prices  return  to  depressed  levels or if our
production  levels  decrease,  our  revenues,  cash  flow  from  operations  and
financial condition will be materially adversely affected.

     Availability  of Capital.  As  described  more fully under  "Liquidity  and
Capital Resources" below, our sources of capital going forward will primarily be
cash from operating  activities,  funding under our revolving  credit  facility,
cash on hand, and if an appropriate  opportunity presents itself,  proceeds from
the sale of  properties.  We  currently  have  approximately  $15.0  million  of
availability under our revolving credit facility.

     Exploitation,  Exploration  and Development  Activity.  We believe that our
high quality asset base, high degree of operational  control and large inventory
of  drilling  projects  position  us  for  future  growth.  Our  properties  are
concentrated  in locations  that  facilitate  substantial  economies of scale in
drilling and  production  operations  and more  efficient  reservoir  management
practices.  At year end  December  31,  2005 we operated  95% of the  properties
accounting for  approximately  94% of our PV-10,  giving us substantial  control
over the timing  and  incurrence  of  operating  and  capital  expenditures.  In
addition,  we had 53 proved  undeveloped  locations and have identified over 184
drilling and recompletion  opportunities on our existing acreage, the successful
development  of  which  we  believe  could  significantly   increase  our  daily
production  and proved  reserves.  During the first nine months of 2006, we made
capital  expenditures of  approximately  $21.3 million for wells in south Texas,
west Texas and Wyoming.  We are  currently  re-entering  a Devonian well in west
Texas and are  recompleting a Wilcox well in south Texas. In the Oates SW Field,
two wells  drilled  earlier this year have been placed on  production  naturally
(without  stimulation) to enable us to evaluate the productive capability of the
wells,  which will allow us to  effectively  design  fracture  stimulations.  We
continue to perform general well  maintenance  and work-overs  utilizing our own
work-over rigs.

     Our future natural gas and crude oil production, and therefore our success,
is highly  dependent  upon our ability to find,  acquire and develop  additional
reserves that are profitable to produce. The rate of production from our natural
gas and crude  oil  properties  and our  proved  reserves  will  decline  as our
reserves are produced unless we acquire additional  properties containing proved
reserves,   conduct   successful   development,   exploitation  and  exploration
activities or, through  engineering  studies,  identify  additional  behind-pipe
zones or secondary recovery reserves. We cannot assure you that our exploration,
exploitation  and development  activities will result in increases in our proved
reserves. In addition,  approximately 52% of our total estimated proved reserves
at December 31, 2005 were undeveloped. By their nature, estimates of undeveloped
reserves are less certain.  Recovery of such  reserves will require  significant
capital expenditures and successful drilling operations.

     Borrowings  and  Interest.  At November  1, 2006,  we had  indebtedness  of
approximately  $125.0 million under the notes and $0 under the revolving  credit
facility and availability of $15.0 million. Unlike the 11 1/2% secured notes due
2007 (which were redeemed in October 2004),  interest on the notes is payable in
cash.

     Recent  events.  On  September  28,  2006 we closed on the sale of  certain
non-core assets located in South Texas for a total consideration of $12 million,
subject to closing  adjustments.  The  effective  date of the sale was August 1,
2006.The  non-core  assets were located in the Three Rivers  (Edwards)  Field of
Live Oak County,  Texas and represented less than 2% of the Company's net proved
reserves as of December 31, 2005 and  approximately 3% of the Company's  current
daily net  production  at July 31,  2006.  The net  proceeds  were used to repay
outstanding indebtedness under the Company's revolving credit facility.

Outlook for 2006. As a result of final 2005 financial results and current market
conditions, our operating and financial guidance for 2006 is as follows:

          Production:
             BCFE (approximately 80% gas)....................... 7.5 - 8.5
          Exit Rate (Mmcfe/d)................................... 22 - 24
          Price Differentials (Pre Hedge):
             Gas (% Mcf)........................................ 15%
             Oil ($/Bbl)........................................ 2.00
          Production taxes (% of Revenue)....................... 10%
          Direct Lease Operating Expenses ($/ Mcfe)............. 1.10
          G&A ($/ Mcfe)......................................... 0.55
          Interest ($/Mcfe)..................................... 2.00


                                       15


          DD&A ($/Mcfe)......................................... 1.80
          Capital Expenditures ($ Millions)..................... 23.0 - 25.0 (1)
          (1) Our  capital  expenditures  are  subject to adequate
          cash flow from  operations  and  availability  under our
          revolving credit facility. For more information,  please
          see    "Liquidity    Capital    Resources    -   Capital
          Expenditures" below.


Results of Operations

     The  following  table sets  forth  certain  of our  operating  data for the
periods presented.



                                                          Three Months Ended              Nine Months Ended
                                                            September 30,                   September 30,
                                                      --------------------------      ---------------------------
                                                         2006            2005           2006             2005
                                                       ---------       ---------      ----------       ----------
                                                                                        
Operating Revenue (in thousands):
Crude Oil Sales..................................   $     3,478     $     2,699    $      9,620     $      7,543
Natural Gas Sales................................         9,369          11,130          29,022           23,147
Rig Operations...................................           363             330           1,168              909
Other............................................             6               5              15               14
                                                       ---------       ---------      ----------       ----------
                                                    $    13,216     $    14,164    $     39,825     $     31,613
                                                       =========       =========      ==========       ==========

Operating Income (in thousands) .................   $     5,426     $     7,905    $     16,509     $     14,570
Crude Oil Production (MBbls).....................            52              45             150              145
Natural Gas Production (MMcfs)...................         1,725           1,366           4,926            3,427
Average Crude Oil Sales Price ($/Bbl)............   $     66.62     $     60.24    $      64.24     $      51.95
Average Natural Gas Sales Price ($/Mcf)..........   $      5.43     $      8.15    $       5.89     $       6.75


Comparison  of Three  Months  Ended  September  30, 2006 to Three  Months  Ended
September 30, 2005

     Operating  Revenue.  During the three  months  ended  September  30,  2006,
operating revenue from natural gas and crude oil sales decreased by $1.0 million
to $12.8 million  compared to $13.8 million during three months ended  September
30, 2005.  The decrease in revenue was due to a decrease in the price of natural
gas during the third quarter of 2006 as compared to the same period of 2005. The
decrease  in  revenue  related  to the  decline  in the  natural  gas  price was
partially  offset by increased  production and higher prices  received for crude
oil during the quarter.  The decline in natural gas prices had a negative impact
on  revenue  of  approximately  $3.7  million.  Higher  natural  gas  production
contributed   $2.0  million  to  revenue  and  increased  crude  oil  production
contributed  $494,000.  The  increase  in the price of crude oil for the quarter
ended September 30, 2006 contributed $286,000 to revenue.

     Average  sales prices net of hedging cost for the quarter  ended  September
30, 2006 were:

         o    $66.62 per Bbl of crude oil, and
         o    $5.43 per Mcf of natural gas


         Average sales prices net of hedging cost for the quarter ended
September 30, 2005 were:

         o    $60.24 per Bbl of crude oil, and
         o    $8.15 per Mcf of natural gas

                                       16


     Crude oil production  volumes  increased from 44.8 MBbls during the quarter
ended September 30, 2005 to 52.2 MBbls for the same period of 2006. The increase
in crude oil production  volumes was primarily due to production  from new wells
in Wyoming which was partially  offset by natural  field  declines.  Natural gas
production  volumes  increased 359 MMcf to 1,725 MMcf for the three months ended
September 30, 2006 from 1,366 MMcf for the same period of 2005.  The increase in
natural gas production was primarily due to new production brought on line since
the third quarter of 2005.  Production  from wells brought on production  during
and since the third quarter of 2005 contributed  793.9 MMcf and 3.7 MBbls during
the third  quarter of 2006 compared to 376.4 MMcf and 0.3 MBbls during the third
quarter  of 2005.  The  increase  in  production  attributable  to new wells was
partially  offset by natural  field  declines and the sale of properties in Live
Oak County, Texas effective August 1, 2006. The properties sold contributed 91.0
MMcf to  production  during the third  quarter of 2005 compared to 47.8 MMcf for
the two months ended August 31, 2006.

     Lease Operating Expenses ("LOE").  LOE for the three months ended September
30, 2006 were  consistent with LOE for the three months ended September 30, 2005
at $3.0 million for each period.  The general  increase in the industry  cost of
services was offset by decreased  production  taxes.  The decline in  production
taxes was due to the  decline in the price  received  for natural gas during the
third  quarter of 2006 as compared to the same period of 2005.  Our LOE on a per
Mcfe basis for the three  months  ended  September  30, 2006  decreased to $1.44
compared to $1.84 for the same period of 2005. The decrease in the per Mcfe rate
was  primarily  due to increased  production  volumes  during the quarter  ended
September 30, 2006 as compared to 2005.

     General  and  Administrative   ("G&A")  Expenses.  G&A  expenses  excluding
stock-based  compensation  decreased to $844,000 for the quarter ended September
30, 2006 from $953,000 for the same period of 2005.  The decrease in G&A expense
was  primarily  due to lower  professional  fees in the third quarter of 2006 as
compared to the same  period of 2005.  G&A expense on a per Mcfe basis was $0.41
for the third quarter of 2006 compared to $0.58 for the same period of 2005. The
per Mcfe  decrease  was  attributable  to lower  G&A  expense  as well as higher
production  volumes  during the third  quarter of 2006 as  compared  to the same
period of 2005.

     Stock-based Compensation.  In December 2004, the FASB issued SFAS No. 123R,
"Share-Based Payment".  SFAS No. 123R is a revision of SFAS No. 123, "Accounting
for Stock Based  Compensation",  and supersedes APB 25. Among other items,  SFAS
123R  eliminates the use of APB 25 and the intrinsic value method of accounting,
and requires  companies to recognize the cost of employee  services  received in
exchange for awards of equity instruments, based on the grant date fair value of
those awards, in the financial statements.

     The  Company  adopted  SFAS 123R in the  fourth  quarter  of 2005 using the
"modified  retrospective  method".  Under the "modified  retrospective  method",
entities are permitted to restate financial statements of previous periods based
on proforma disclosures made in accordance with SFAS 123. This standard requires
the cost of all share-based payments, including stock options, to be measured at
fair value on the grant date and recognized in the statement of  operations.  In
accordance  with  this  standard,  all  periods  prior to  January  1, 2005 were
restated  to reflect  the impact of the  standard  as if it had been  adopted on
January 1, 1995, the original  effective date of SFAS No. 123,  "Accounting  for
Stock-Based  Compensation".  Also in accordance  with the standard,  the amounts
that are reported in the  statement of operations  for the restated  periods are
the pro forma amounts previously disclosed under SFAS No. 123.

     As a result  of the  retrospective  adoption  of SFAS  123R,  the  expenses
previously recognized under the rules of variable accounting were reversed and a
compensation expense measured according to SFAS 123R was recorded.  As a result,
we  recognized  stock-based  compensation  expense of $207,000  during the third
quarter of 2006 as a result of the adoption of this  accounting  change compared
to $16,000 in 2005, as adjusted. Stock-based compensation expense is included as
a  component  of G&A  expense  in the  accompanying  financial  statements.  The
increase  in  stock-based  compensation  expense  for  the  three  months  ended
September  30, 2006 over the same period of 2005 was due to new options  granted
during the latter  part of 2005 and the first part of 2006 and the  increase  in
the  calculated  fair  value of these  grants due to higher  option  prices as a
result of the increase in the price of our Common stock over previous options.

                                       17


     We currently utilize a standard option pricing model (i.e.,  Black-Scholes)
to measure the fair value of stock options granted to employees. While SFAS 123R
permits  entities to continue to use such a model, the standard also permits the
use of a more complex binomial,  or "lattice" model. Based upon research done by
us  on  the  alternative  models  available  to  value  option  grants,  and  in
conjunction  with the type and number of stock options  expected to be issued in
the future,  we have determined  that we will continue to use the  Black-Scholes
model for option valuation as of the current time

     Depreciation,  Depletion and  Amortization("DD&A")  Expenses.  DD&A expense
increased to $3.6 million for the three  months  ended  September  30, 2006 from
$2.1 million for the same period of 2005. The increase in DD&A was primarily due
to increased  production volumes in the third quarter of 2006 as compared to the
same period of 2005 as well as an increase in projected future  development cost
in 2006 as compared to 2005.  Our DD&A on a per Mcfe basis for the quarter ended
September 30, 2006 was $1.78 per Mcfe as compared to $1.29 in 2005. The increase
in the per Mcfe rate was due to higher  production  volumes in the quarter ended
September  30, 2006 as  compared to 2005 as well as a increased  base due to the
increase in projected future development cost in 2006 as compared to 2005.

     Interest Expense.  Interest expense increased to $4.4 million for the third
quarter  of 2006  compared  to $3.7  million  for the same  period of 2005.  The
increase in interest  expense was due to an increase in our interest rate on our
floating rate senior secured notes and our senior  revolving  credit facility as
well as an increase in the amount borrowed under our revolving credit facility.

     Income taxes. There is no current or deferred income tax expense or benefit
due to losses  or loss  carryforwards  and  valuation  allowance  which has been
recorded against such benefits.

Comparison  of Nine  Months  Ended  September  30,  2006 to  Nine  Months  Ended
September 30, 2005

     Operating  Revenue.  During  the nine  months  ended  September  30,  2006,
operating revenue from natural gas and crude oil sales increased by $7.9 million
to $38.6 million as compared to $30.7 million in the nine months ended September
30, 2005. The increase in revenue was primarily due to higher production volumes
during  the first nine  months of 2006 as  compared  to the same  period of 2005
which was  partially  offset by a decrease  in  natural  gas  prices.  Increased
natural gas production volumes contributed $10.2 million and increased crude oil
production  contributed $237,000 to revenue. The decline in the price of natural
gas during the nine months  ended  September  30, 2006 had a negative  impact on
revenue  of $4.2  million  which  was  partially  offset by an  increase  in the
realized  crude  oil  price  during  the  period.  Increased  crude  oil  prices
contributed $1.8 million to revenue during the period.

     Average  sales  prices  net of  hedging  cost  for the  nine  months  ended
September 30, 2006 were:

         o    $64.24 per Bbl of crude oil, and
         o    $5.89 per Mcf of natural gas

         Average sales prices net of hedging cost for the nine months ended
September 30, 2005 were:

         o    $51.95 per Bbl of crude oil, and
         o    $6.75 per Mcf of natural gas

     Crude oil production  volumes increased  slightly to 149.8 MBbls during the
nine  months  ended  September  30, 2006 from 145.2 MBbls for the same period of
2005.  The  increase  in crude  oil  production  volumes  was  primarily  due to
production from new wells in Wyoming and south Texas, which was partially offset
by natural field  declines.  Natural gas production  volumes  increased by 1,499
MMcf to 4,926 MMcf for the nine months ended  September 30, 2006 from 3,427 MMcf
MMcf for the same period of 2005. Production from wells brought on to production
during and since the third quarter of 2005 contributed  2,223 MMcf and 5.2 MBbls
during the nine months ended  September  30, 2006 compared to 485.0 MMcf and 0.4
MBbls during the same period of 2005. The increase in production attributable to
new wells was partially offset by natural field declines.

                                       18


     Lease Operating Expenses.  LOE for the nine months ended September 30, 2006
increased to $8.5  million  from $7.8  million for the same period of 2005.  The
increase was primarily due to a general  increase in the cost of field services.
Our LOE on a per Mcfe  basis  for the  nine  months  ended  September  30,  2006
decreased to $1.45  compared to $1.82 for the same period of 2005.  The decrease
in the per Mcfe rate was primarily due to increased  production  volumes in 2006
as compared to 2005.

     G&A Expenses. G&A expenses, excluding stock-based compensation decreased to
$2.9  million  for the first nine  months of 2006 from to $3.0  million  for the
first nine months of 2005.  The decrease in G&A expense was  primarily  due to a
decrease in professional fees. G&A expense on a per Mcfe basis was $0.50 for the
first nine months of 2006 compared to $0.70 for the same period of 2005. The per
Mcfe decrease was primarily attributable to higher production volumes in 2006.

     Stock-based Compensation.  In December 2004, the FASB issued SFAS No. 123R,
"Share-Based Payment".  SFAS No. 123R is a revision of SFAS No. 123, "Accounting
for Stock Based  Compensation",  and supersedes APB 25. Among other items,  SFAS
123R  eliminates the use of APB 25 and the intrinsic value method of accounting,
and requires  companies to recognize the cost of employee  services  received in
exchange for awards of equity instruments, based on the grant date fair value of
those awards, in the financial statements.

     The  Company  adopted  SFAS 123R in the  fourth  quarter  of 2005 using the
"modified  prospective  method".  Under  the  "modified  retrospective  method",
entities are permitted to restate financial statements of previous periods based
on proforma disclosures made in accordance with SFAS 123. This standard requires
the cost of all share-based payments, including stock options, to be measured at
fair value on the grant date and recognized in the statement of  operations.  In
accordance  with  this  standard,  all  periods  prior to  January  1, 2005 were
restated  to reflect  the impact of the  standard  as if it had been  adopted on
January 1, 1995, the original  effective date of SFAS No. 123,  "Accounting  for
Stock-Based  Compensation".  Also in accordance  with the standard,  the amounts
that are reported in the  statement of operations  for the restated  periods are
the pro forma amounts previously disclosed under SFAS No. 123.

     As a result  of the  retrospective  adoption  of SFAS  123R,  the  expenses
previously recognized under the rules of variable accounting were reversed and a
compensation expense measured according to SFAS 123R was recorded.  As a result,
we  recognized  stock-based  compensation  expense of  $578,000  during the nine
months ended  September 30, 2006 as a result of the adoption of this  accounting
change  compared  to  $57,000 in 2005,  as  adjusted.  Stock-based  compensation
expense is included as a component of G&A expense in the accompanying  financial
statements. The increase in stock-based compensation expense for the nine months
ended  September  30,  2006 over the same  period of 2005 was due to new options
granted during the latter part of 2005 and the first nine months of 2006 and the
increase  in the  calculated  fair value of these  grants  due to higher  option
prices  as a result  of the  increase  in the  price of our  Common  stock  over
previous options.

     We currently utilize a standard option pricing model (i.e.,  Black-Scholes)
to measure the fair value of stock options granted to employees. While SFAS 123R
permits  entities to continue to use such a model, the standard also permits the
use of a more complex binomial,  or "lattice" model. Based upon research done by
us  on  the  alternative  models  available  to  value  option  grants,  and  in
conjunction  with the type and number of stock options  expected to be issued in
the future,  we have determined  that we will continue to use the  Black-Scholes
model for option valuation as of the current time.

     DD&A Expenses.  DD&A expense increased to $10.8 million for the nine months
ended  September  30, 2006 from $5.6  million  for the same period of 2005.  The
increase in DD&A was primarily due to increased  production  volumes in the nine
months of 2006 as  compared to the same period of 2005 as well as an increase in
projected future development cost in 2006 as compared to 2005. Our DD&A on a per
Mcfe basis for the nine months  ended  September  30, 2006 was $1.85 per Mcfe as
compared to $1.31 in 2005.  This  increase  was the result of higher  production
volumes  and  the  increase  in  projected  future  development  cost in 2006 as
compared to 2005.

     Interest Expense. Interest expense increased to $12.5 million for the first
nine months of 2006 compared to $10.2  million for the same period of 2005.  The


                                       19


increase in interest  expense was due to an increase in our interest rate on our
floating  rate senior  secured  notes and our senior  secured  revolving  credit
facility  as well as an  increase  in the amount  borrowed  under our  revolving
credit facility.

     Income taxes. There is no current or deferred income tax expense or benefit
due to losses  or loss  carryforwards  and  valuation  allowance  which has been
recorded against such benefits.

Liquidity and Capital Resources

     General.  The  natural  gas and  crude  oil  industry  is a highly  capital
intensive and cyclical business. Our capital requirements are driven principally
by our  obligations  to  service  debt and to fund the  following  costs:

         o    the  development of existing  properties,  including  drilling and
              completion costs of wells;

         o    acquisition of interests in natural gas and crude oil  properties;
              and

         o    production and transportation facilities.

The amount of capital  expenditures  we are able to make has a direct  impact on
our ability to increase cash flow from operations,  and, thereby,  will directly
affect our ability to service our debt  obligations  and to continue to grow the
business  through the development of existing  properties and the acquisition of
new properties.

     Our sources of capital going forward will  primarily be cash from operating
activities, funding under our revolving credit facility, cash on hand, and if an
appropriate  opportunity presents itself,  proceeds from the sale of properties.
However,  under the terms of the notes, proceeds of optional sales of our assets
that are not timely  reinvested  in new natural gas and crude oil assets will be
required to be used to reduce  indebtedness and proceeds of mandatory sales must
be used to repay or redeem  indebtedness.  All of the proceeds  from the sale of
the Live Oak County,  Texas  properties  in  September  2006 were used to re-pay
indebtdness under our revolving credit facility.

     Working Capital (Deficit).  At September 30, 2006, we had current assets of
$8.4 million and current  liabilities  of $11.6  million  resulting in a working
capital  deficit of  approximately  $3.2  million.  This  compares  to a working
capital  deficit of $4.9 million at December 31, 2005.  Current  liabilities  at
September 30, 2006  consisted of trade  payables of $2.0  million,  revenues due
third  parties of $2.6  million,  accrued  interest  of $5.5  million  and other
accrued liabilities of $1.5 million.

     Capital  expenditures.  The table  below sets forth the  components  of our
capital  expenditures on a historical  basis for the nine months ended September
30, 2006 and 2005.

                                                         Nine Months Ended
                                                           September 30,
                                                 ------------------------------
                                                    2006               2005
                                                 -------------    -------------
Expenditure category (in thousands):
  Development............................... $       21,141     $     28,350
  Facilities and other......................            149              254
                                                 -------------    -------------
      Total................................. $       21,290     $     28,604
                                                 =============    =============

     We have no material long-term capital commitments and are consequently able
to adjust the level of our expenditures as circumstances  dictate.  The level of
capital  expenditures  will  vary  during  future  periods  depending  on market
conditions and other related economic factors effecting cash flow.

     At the start of 2006, we anticipated making capital expenditures, primarily
for the development of our current  properties,  of approximately  $40.0 million
which was based upon the anticipated amount of our cash flow from operations and
availability  under our revolving  credit  facility.  As natural gas prices have
decreased  during the first nine months of 2006,  our cash flow from  operations
has not reached the levels  that we had  anticipated.  As a result we will spend
less than the original  budget of $40.0 million.  We expect to spend between $23
million and $25 million on capital  expenditures  for 2006.  Our ability to make
all of our budgeted capital expenditures will also be subject to availability of
drilling rigs and other field equipment and services.  Our capital  expenditures
could also include  expenditures for acquisition of producing properties if such


                                       20


opportunities  arise,  but we  currently  have no  agreements,  arrangements  or
undertakings regarding any material  acquisitions.  Should the prices of natural
gas continue to decline,  crude oil prices begin to decline,  or if our costs of
operations  increase  as a result of the  scarcity  of  drilling  rigs or if our
production  volumes decrease,  our cash flow from operations will decrease which
may result in a further reduction of the capital expenditures budget.

     Sources of  Capital.  The net funds  provided by and/or used in each of the
operating,  investing  and  financing  activities,  all  relating to  continuing
operations, are summarized in the following table:



                                                                Nine Months Ended
                                                                  September 30,
                                                        ---------------------------------
                                                            2006                 2005
                                                        ---------------    --------------
                                                                  
Net cash provided by operating activities             $       13,290    $         14,769
Net cash used in investing activities                         (9,421)            (28,604)
Net cash (used in) provided by financing activities           (2,882)             15,134
                                                        ---------------    --------------
Total                                                 $          987    $          1,299
                                                        ===============    ==============



     Operating  activities  during the nine  months  ended  September  30,  2006
provided  $13.3 million in cash compared to providing  $14.8 million in the same
period in 2005.  Net  income  plus  non-cash  expense  items and net  changes in
operating  assets and liabilities  accounted for most of these funds.  Financing
activities  used $2.9  million  for the first nine  months of 2006  compared  to
providing approximately $15.1 million for the first nine months of 2005. For the
nine  months  ended  September  30,  2006,  proceeds  from long- term  borrowing
provided  $18.3  million  while  payments  on  long-term  borrowings  used $14.9
million. Proceeds from long-term borrowings provided $17.7 million in 2005 while
payments on long-term  borrowings  used $14.3 million in 2005.  Proceeds from an
equity  offering in July 2005  provided  $11.3 million for the nine months ended
September 30, 2005.  Investing  activities used $9.4 million for the nine months
ended September 30, 2006.  Capital  expenditures of $21.3 million were offset by
proceeds  from the sale of non-core  oil and gas  properties  of $11.9  million.
Investing  activities used $28.6 million for the nine months ended September 30,
2005. Expenditures during the nine months ended September 30, 2006 and 2005 were
primarily for the development of existing properties.

     Future  Capital  Resources.  We currently have three  principal  sources of
liquidity going forward: (i) cash from operating activities,  (ii) funding under
our revolving credit facility, and (iii) if an appropriate  opportunity presents
itself, the sale of producing  properties.  If these sources of liquidity do not
prove to be sufficient, we may also issue additional shares of equity securities
although we may not be able to complete equity financings on terms acceptable to
us, if at all.  Covenants  under the  indenture  for the notes and the revolving
credit facility restrict our use of cash from operating activities, cash on hand
and any  proceeds  from asset sales.  Under the terms of the notes,  proceeds of
optional  sales of our assets that are not timely  reinvested in new natural gas
and crude oil assets  will be  required  to be used to reduce  indebtedness  and
proceeds of mandatory  sales must be used to redeem  indebtedness.  The terms of
the notes and the  revolving  credit  facility also  substantially  restrict our
ability to:

         o    incur additional indebtedness;

         o    grant liens;

         o    pay dividends or make certain other restricted payments;

         o    merge or consolidate with any other entity; or

         o    sell, assign, transfer,  lease, convey or otherwise dispose of all
              or substantially all of our assets.

     Our cash flow from operations  depends heavily on the prevailing  prices of
natural  gas and crude oil and our  production  volumes of natural gas and crude
oil.  Although  we have  hedged a  portion  of our  natural  gas and  crude  oil
production and will continue this practice as required pursuant to the revolving
credit  facility,  future  natural gas and crude oil price declines would have a
material  adverse effect on our overall results,  and therefore,  our liquidity.
Falling  natural  gas and crude oil  prices  could  also  negatively  affect our
ability to raise capital on terms favorable to us or at all.

                                       21


     Our cash flow from  operations  will also depend upon the volume of natural
gas and crude oil that we produce.  Unless we  otherwise  expand  reserves,  our
production  volumes  may  decline  as  reserves  are  produced.  Due to sales of
properties  in 2002 and 2003,  the  divestiture  of Grey Wolf  during  the first
quarter of 2005, and restrictions on capital expenditures under the terms of our
11 1/2% secured notes due 2007 (which were  refinanced in October 2004),  we now
have  significantly  reduced  reserves and  production as compared with pre-2003
levels.  In the future,  if an appropriate  opportunity  presents itself, we may
sell additional  properties,  which could further reduce our production volumes.
To offset the loss in production  volumes  resulting from natural field declines
and sales of producing  properties,  we must conduct  successful,  exploitation,
exploration and development activities,  acquire additional producing properties
or identify  additional  behind-pipe zones or secondary  recovery  reserves.  We
believe  our  numerous  drilling  opportunities  will allow us to  increase  our
production  volumes;  however,  our drilling  activities are subject to numerous
risks,  including the risk that no commercially  productive natural gas or crude
oil reservoirs will be found.  The risk of not finding  commercially  productive
reservoirs will be compounded by the fact that 52% of our total estimated proved
reserves at December 31, 2005 were undeveloped.  During the first nine months of
2006, we expended  approximately  $21.3  million for wells in south Texas,  west
Texas and Wyoming.  We are  currently  re-entering a Devonian well in west Texas
and are  recompleting a Wilcox well in south Texas.  In the Oates SW Field,  two
wells  drilled  earlier  this  year have been  placed  on  production  naturally
(without  stimulation) to enable us to evaluate the productive capability of the
wells  which will  allow us to  effectively  design  fracture  stimulations.  We
continue to perform general well  maintenance  and work-overs  utilizing our own
work-over  rigs. In addition,  approximately  29% of our production at September
30,  2006 was from a single  well in west Texas.  If  production  from this well
decreases,  the volume of our  production  would also decrease  which,  in turn,
would likely cause our cash flow from operations to decrease.

     Our total indebtedness and cash interest expense as a result of issuing the
notes and entering into the revolving credit facility require us to increase our
production  and cash  flow  from  operations  in order to meet our debt  service
requirements,  as well as to  fund  the  development  of our  numerous  drilling
opportunities. The ability to satisfy these new obligations will depend upon our
drilling success as well as prevailing commodity prices.

Contractual Obligations

    We are committed to making cash payments in the future on the following
types of agreements:

         o    Long-term debt

         o    Operating leases for office facilities

We have no  off-balance  sheet debt or  unrecorded  obligations  and we have not
guaranteed  the debt of any  other  party.  Below is a  schedule  of the  future
payments  that we are  obligated  to make  based  on  agreements  in place as of
September 30, 2006:



                                 Payments due in twelve month periods ended:
                         -------------------------------------------------------------------------------------
Contractual                                 September 30,      September 30,     September 30,
Obligations (dollars         Total             2007             2008-2009         2010-2011       Thereafter
in thousands)
--------------------------------------------------------------------------------------------------------------
                                                                                   
Long-Term Debt (1)        $   126,077     $        -         $    1,077         $  125,000        $        -
Interest on long-term
debt (2)                       50,954         16,125             32,158              2,671                 -
Operating Leases (3)              589            254                335                  -                 -
                          --------------- ------------------ ------------------ ----------------- -------------
    Total                 $   177,620     $   16,379         $   33,570         $  127,671        $        -
                          =============== ================== ================== ================= =============


(1)      These amounts  represent the balances  outstanding  under the revolving
         credit facility and the notes. These repayments assume that we will not
         draw down additional funds
(2)      Interest  expense  assumes the balances of long-term debt at the end of
         the period and  current  effective  interest  rates.
(3)      Office  lease  obligations.  The lease  for  office  space for  Abraxas
         expires in 2009


                                       22


     Other  obligations.  We make and will continue to make substantial  capital
expenditures for the  acquisition,  exploitation,  development,  exploration and
production  of  natural  gas and crude  oil.  In the past,  we have  funded  our
operations and capital expenditures primarily through cash flow from operations,
sales of properties,  sales of production payments and borrowings under our bank
credit facilities and other sources. Given our high degree of operating control,
the timing and  incurrence  of  operating  and capital  expenditures  is largely
within our discretion.



Long-Term Indebtedness

                                                     September 30,     December 31,
                                                         2006               2005
                                                    ----------------  -----------------
                                                              (In thousands)
                                                                   
Floating rate senior secured notes due 2009.......    $    125,000       $   125,000
Senior secured revolving credit facility..........           1,077             4,527
                                                    ----------------  -----------------
                                                           126,077           129,527
Less current maturities ..........................               -                 -
                                                    ----------------  -----------------
                                                       $    126,077      $   129,527
                                                    ================  =================


     Floating Rate Senior Secured Notes due 2009. In connection with the October
2004 financial restructuring, Abraxas issued $125 million in principal aggregate
amount of Floating Rate Senior  Secured Notes due 2009. The notes will mature on
December 1, 2009 and began accruing interest from the date of issuance,  October
28, 2004 at a per annum floating rate of six-month LIBOR plus 7.50%. The current
interest rate is 12.82% per annum.  The interest rate is reset  semi-annually on
each June 1 and December 1. Interest is payable semi-annually in arrears on June
1 and December 1 of each year.

     The notes rank equally among themselves and with all of our  unsubordinated
and unsecured indebtedness, including our credit facility and senior in right of
payment to our existing and future subordinated indebtedness.

     Each of our  subsidiaries,  Eastside Coal Company,  Inc.,  Sandia Oil & Gas
Corporation,  Sandia  Operating  Corp.,  Wamsutter  Holdings,  Inc.  and Western
Associated Energy Corporation (collectively,  the "Subsidiary Guarantors"),  has
unconditionally guaranteed, jointly and severally, the payment of the principal,
premium and interest on the notes on a senior  secured basis.  In addition,  any
other  subsidiary or affiliate of ours, that in the future  guarantees any other
indebtedness with us, or our restricted  subsidiaries,  will also be required to
guarantee the notes.

     The notes and the Subsidiary Guarantors' guarantees thereof,  together with
our revolving credit facility and the Subsidiary Guarantors' guarantees thereof,
are secured by shared first priority  perfected security  interests,  subject to
certain  permitted  encumbrances,  in all  of our  and  each  of our  restricted
subsidiaries' material property and assets,  including  substantially all of our
and their natural gas and crude oil  properties and all of the capital stock (or
in  the  case  of  an  unrestricted  subsidiary  that  is a  controlled  foreign
corporation, up to 65% of the outstanding capital stock) of any entity, owned by
us and our restricted subsidiaries (collectively, the "Collateral").

     The notes may be redeemed, at our election, as a whole or from time to time
in part,  at any time after April 28, 2007,  upon not less than 30 nor more that
60  days'  notice  to each  holder  of  notes  to be  redeemed,  subject  to the
conditions and at the redemption  prices  (expressed as percentages of principal
amount)  set  forth  below,  together  with  accrued  and  unpaid  interest  and
Liquidating  Damages( as defined in the  indenture)  if any,  to the  applicable
redemption date.

                              Year                               Percentage
           -------------------------------------------------------------------
           From April 29, 2007 to April 28, 2008                   104.00%
           From April 29, 2008 to April 28, 2009                   102.00%
           After April 28, 2009                                    100.00%

                                       23


Prior to April  28,  2007,  we may  redeem up to 35% of the  aggregate  original
principal  amount of the  notes  using the net  proceeds  of one or more  equity
offerings,  in each case at the redemption price equal to the product of (i) the
principal  amount of the notes being so  redeemed  and (ii) a  redemption  price
factor of 1.00 plus the per annum  interest  rate on the notes  (expressed  as a
decimal) on the applicable  redemption  date plus accrued and unpaid interest to
the applicable redemption date, provided certain conditions are also met.

     If we experience specific kinds of change of control events, each holder of
notes may require us to repurchase  all or any portion of such holder's notes at
a  purchase  price  equal to 101% of the  principal  amount of the  notes,  plus
accrued and unpaid interest to the date of repurchase.

     The indenture  governing the notes  contains  covenants  that,  among other
things, limit our ability to:

         o    incur or guarantee additional indebtedness and issue certain types
              of preferred stock or redeemable stock;

         o    transfer or sell assets;

         o    create liens on assets;

         o    pay dividends or make other distributions on capital stock or make
              other restricted payments,  including  repurchasing,  redeeming or
              retiring  capital  stock or  subordinated  debt or making  certain
              investments or acquisitions;

         o    engage in transactions with affiliates;

         o    guarantee other indebtedness;

         o    permit   restrictions  on  the  ability  of  our  subsidiaries  to
              distribute or lend money to us;

         o    cause a restricted subsidiary to issue or sell its' capital stock;
              and

         o    consolidate,  merge or transfer  all or  substantially  all of the
              consolidated assets of our and our restricted subsidiaries.

The indenture also contains customary events of default, including nonpayment of
principal  or  interest,  violations  of  covenants,  cross  default  and  cross
acceleration  to certain other  indebtedness,  including  our  revolving  credit
facility, bankruptcy, and material judgments and liabilities.

     Senior Secured  Revolving Credit Facility.  On October 28, 2004, we entered
into an agreement for a revolving credit facility having a maximum commitment of
$15 million,  which includes a $2.5 million  subfacility  for letters of credit.
Availability  under the revolving credit facility is subject to a borrowing base
consistent  with  normal  and  customary  natural  gas  and  crude  oil  lending
transactions.

     Outstanding  amounts under the revolving  credit  facility bear interest at
the prime rate announced by Wells Fargo Bank,  National  Association plus 1.00%.
The current  interest  rate is 9.25% per annum.  Subject to earlier  termination
rights  and events of  default,  the stated  maturity  date under the  revolving
credit facility is October 28, 2008.

     We are  permitted to terminate  the revolving  credit  facility,  and under
certain circumstances, may be required, from time to time, to permanently reduce
the lenders'  aggregate  commitment under the revolving  credit  facility.  Such
termination  and each  such  reduction  is  subject  to a  premium  equal to the
percentage  listed below multiplied by the lenders'  aggregate  commitment under
the revolving credit facility, or, in the case of partial reduction,  the amount
of such reduction.


                                       24

                                         Year             % Premium
                                      -------------- --------------------
                                            1                1.5
                                            2                1.0
                                            3                0.5
                                            4                0.0

     Each of our current  subsidiaries  has  guaranteed,  and each of our future
restricted  subsidiaries  will guarantee,  our  obligations  under the revolving
credit facility on a senior secured basis. In addition,  any other subsidiary or
affiliate of ours, that in the future  guarantees any of our other  indebtedness
or of our restricted  subsidiaries will be required to guarantee our obligations
under the revolving  credit  facility.  Obligations  under the revolving  credit
facility  are  secured,  together  with the notes,  by a shared  first  priority
perfected security interest,  subject to certain permitted encumbrances,  in all
of our and each of our restricted  subsidiaries'  material  property and assets,
including  substantially  all of  our  and  their  natural  gas  and  crude  oil
properties  and all of the  capital  stock  (or in the  case of an  unrestricted
subsidiary  that  is  a  controlled  foreign  corporation,  up  to  65%  of  the
outstanding  capital  stock)  in any  entity,  owned  by us and  our  restricted
subsidiaries.

     Under the revolving credit facility, we are subject to customary covenants,
including certain financial covenants and reporting requirements.  The revolving
credit facility requires us to maintain a minimum net cash interest coverage and
also  requires us to enter into hedging  agreements on not less than 25% or more
than 75% of our projected natural gas and crude oil production.

     In addition to the foregoing and other customary  covenants,  the revolving
credit  facility  contains  a number of  covenants  that,  among  other  things,
restrict Abraxas' ability to:

         o    incur or guarantee additional indebtedness and issue certain types
              of preferred stock or redeemable stock;

         o    transfer or sell assets;

         o    create liens on assets;

         o    pay dividends or make other distributions on capital stock or make
              other restricted payments,  including  repurchasing,  redeeming or
              retiring  capital  stock or  subordinated  debt or making  certain
              investments or acquisitions;

         o    engage in transactions with affiliates;

         o    guarantee other indebtedness;

         o    make any change in the principal nature of our business;

         o    prepay,  redeem,  purchase or otherwise  acquire any of our or our
              restricted subsidiaries' indebtedness;

         o    permit a change of control;

         o    directly or indirectly make or acquire any investment;

         o    cause a restricted  subsidiary to issue or sell our capital stock;
              and

         o    consolidate,  merge or transfer  all or  substantially  all of the
              consolidated assets of Abraxas and our restricted subsidiaries.

     The revolving  credit facility also contains  customary  events of default,
including  nonpayment of principal or interest,  violations of covenants,  cross
default and cross  acceleration  to certain other  indebtedness,  bankruptcy and
material judgments and liabilities, and is subject to an Intercreditor, Security
and  Collateral  Agency  Agreement,  which  specifies  the rights of the parties
thereto to the proceeds from the Collateral.

     Intercreditor  Agreement.  The  holders  of the  notes,  together  with the
lenders under our credit facility, are subject to an Intercreditor, Security and
Collateral Agency  Agreement,  which specifies the rights of the parties thereto
to the proceeds from the Collateral.  The Intercreditor  Agreement,  among other
things,  (i)  creates  security  interests  in  the  Collateral  in  favor  of a
collateral  agent for the  benefit  of the  holders  of the notes and the credit


                                       25


facility  lenders and (ii) governs the  priority of payments  among such parties
upon notice of an event of default under the Indenture or the credit facility.

     So long as no such event of default exists,  the collateral  agent will not
collect  payments  under the new  credit  facility  documents  or the  indenture
governing  the  notes and  other  note  documents  (collectively,  the  "Secured
Documents"),  and all payments will be made directly to the respective  creditor
under the applicable  Secured  Document.  Upon notice of an event of default and
for so long as an event of default  exists,  payments  to each  credit  facility
lender and holder of the notes from us and our current subsidiaries and proceeds
from any disposition of any collateral,  will, subject to limited exceptions, be
collected by the collateral agent for deposit into a collateral account and then
distributed as provided in the following paragraph.

     Upon notice of any such event of default and so long as an event of default
exists,  funds in the  collateral  account will be distributed by the collateral
agent generally in the following order of priority:

         first,  to reimburse  the  collateral  agent for  expenses  incurred in
protecting and realizing upon the value of the Collateral;

         second, to reimburse the credit facility  administrative  agent and the
trustee,  on a pro rata basis, for expenses incurred in protecting and realizing
upon the value of the Collateral while any of these parties was acting on behalf
of the Control Party (as defined below);

         third,  to reimburse the credit facility  administrative  agent and the
trustee,  on a pro rata basis, for expenses incurred in protecting and realizing
upon the value of the  Collateral  while any of these  parties was not acting on
behalf of the Control Party;

         fourth,  to pay all  accrued and unpaid  interest  (and then any unpaid
commitment fees) under the credit facility;

         fifth, if, the collateral coverage value of three times the outstanding
obligations  under the credit  facility  would be met after giving effect to any
payment under this clause "fifth," to pay all accrued and unpaid interest on the
notes;

         sixth, to pay all  outstanding  principal of (and then any other unpaid
amounts,  including,  without  limitation,  any  fees,  expenses,  premiums  and
reimbursement obligations) the credit facility;

         seventh,  to pay all accrued  and unpaid  interest on the notes (if not
paid under clause "fifth");

         eighth, to pay all outstanding  principal of (and then any other unpaid
amounts, including,  without limitation, any premium with respect to) the notes;
and

         ninth, to pay each credit  facility  lender,  holder of the notes,  and
other secured party, on a pro rata basis,  all other amounts  outstanding  under
the credit facility and the notes.

     To the extent there exists any excess monies or property in the  collateral
account  after all of ours and our  subsidiaries'  obligations  under the credit
facility,  the indenture and the notes are paid in full,  the  collateral  agent
will be required to return such excess to us.

     The  collateral  agent  will  act  in  accordance  with  the  Intercreditor
Agreement  and as  directed by the  "Control  Party"  which for  purposes of the
Intercreditor  Agreement  is the  holders of the notes and the  credit  facility
lenders,  acting as a single class,  by vote of the holders of a majority of the
aggregate  principal amount of outstanding  obligations  under the notes and the
credit facility.

     The  Intercreditor   Agreement   provides  that  the  lien  on  the  assets
constituting  part of the  Collateral  that is sold or otherwise  disposed of in
accordance  with the terms of each  Secured  Document  may be released if (i) no
default or event of default exists under any of the Secured  Documents,  (ii) we
have delivered an officers'  certificate to each of the  collateral  agent,  the
trustee,  the credit facility  administrative agent certifying that the proposed
sale or other  disposition of assets is either  permitted or required by, and is


                                       26


in accordance with the provisions of, the applicable Secured Documents and (iii)
the collateral agent has acknowledged such certificate.

     The  Intercreditor  Agreement  provides  for the  termination  of  security
interests on the date that all obligations  under the Secured Documents are paid
in full.


Hedging Activities

     Our results of operations are  significantly  affected by  fluctuations  in
commodity  prices  and we seek to reduce our  exposure  to price  volatility  by
hedging our  production  through  commodity  derivative  instruments.  Under the
revolving  credit  facility,  we are required to maintain hedge positions on not
less than 25% nor more than 75% of our  projected oil and gas  production  for a
rolling six month period.

Net Operating Loss Carryforwards

     At  December  31,  2005,  we  had  $190.0  million  of net  operating  loss
carryforwards  for U.S.  tax  purposes.  These loss  carryforwards  will  expire
through 2025 if not utilized.

     Uncertainties  exist as to the future  utilization  of the  operating  loss
carryforwards  under the  criteria  set forth  under  FASB  Statement  No.  109.
Therefore  there is no current or deferred  income tax expense or benefit due to
losses  and/or  loss  carryforwards,  and a valuation  allowance  which has been
recorded against such benefits.


Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Commodity Price Risk

     As an  independent  natural gas and crude oil producer,  our revenue,  cash
flow from operations, other income and profitability,  reserve values, access to
capital  and  future  rate  of  growth  are  substantially  dependent  upon  the
prevailing prices of natural gas, natural gas liquids and crude oil. Declines in
commodity  prices will  materially  adversely  affect our  financial  condition,
liquidity,  ability to obtain financing and operating  results.  Lower commodity
prices may reduce  the amount of natural  gas and crude oil that we can  produce
economically.  Prevailing  prices  for  such  commodities  are  subject  to wide
fluctuation  in response to relatively  minor changes in supply and demand and a
variety of additional  factors beyond our control,  such as global political and
economic conditions. Historically, prices received for natural gas and crude oil
production have been volatile and unpredictable, and such volatility is expected
to continue. Most of our production is sold at market prices.  Generally, if the
commodity  indexes fall, the price that we receive for our production  will also
decline.  Therefore,  the  amount  of  revenue  that  we  realize  is  partially
determined  by factors  beyond our control.  Assuming the  production  levels we
attained  during the nine months  ended  September  30,  2006,  a 10% decline in
natural  gas,  natural gas liquids and crude oil prices  would have  reduced our
operating  revenue,  cash flow and net income by approximately  $3.9 million for
the period.

Hedging Sensitivity

     On  January 1,  2001,  we adopted  SFAS 133 as amended by SFAS 137 and SFAS
138.  Under SFAS 133,  all  derivative  instruments  are recorded on the balance
sheet at fair  value.  If the  derivative  does not qualify as a hedge or is not
designated  as a  hedge,  the  gain  or  loss on the  derivative  is  recognized
currently in earnings.  To qualify for hedge  accounting,  the  derivative  must
qualify either as a fair value hedge, cash flow hedge or foreign currency hedge.
None of the  derivatives  in place as of September  30, 2005 are  designated  as
hedges.  Accordingly,  the  change  in the  market  value of the  instrument  is
reflected in current oil and gas revenue.

     Under  the terms of the  revolving  credit  facility,  we are  required  to
maintain hedging positions on not less than 25% nor more than 75% of our natural
gas and crude oil production for a rolling six month period.

     See "General - Commodity  Prices and Hedging  Activities"  for a summary of
our current hedge positions.

                                       27


Interest Rate Risk

     At September  30, 2006 we had $125.0  million in  outstanding  indebtedness
under the floating rate senior  secured notes due 2009.  The notes bear interest
at a per annum rate of six-month  LIBOR plus 7.5%. The rate is  redetermined  on
June 1 and December 1 of each year,  beginning June 1, 2005. The current rate on
the notes is 12.82%.  For every  percentage point that the LIBOR rate rises, our
interest  expense  would  increase by  approximately  $1.3  million on an annual
basis.  At September 30, 2006, we had $1.1 million of  outstanding  indebtedness
under our revolving  credit  facility.  Interest on this facility accrues at the
prime rate announced by Wells Fargo Bank plus 1.00%.  For every percentage point
increase in the announced  prime rate,  our interest  expense would  increase by
approximately $11,000 on an annual basis.


Item 4. Controls and Procedures.

     As of the end of the period  covered by this  report,  our Chief  Executive
Officer  and  Chief   Financial   Officer  carried  out  an  evaluation  of  the
effectiveness  of Abraxas'  "disclosure  controls and procedures" (as defined in
the Securities Exchange Act of 1934 Rules 13a-15(e)and  15d-15(e)) and concluded
that the  disclosure  controls and  procedures  were  effective  and designed to
ensure  that  material  information  relating  to Abraxas  and our  consolidated
subsidiaries  which is required to be included in our  periodic  Securities  and
Exchange  Commission  filings would be made known to them by others within those
entities.  There  were  no  changes  in our  internal  controls  over  financial
reporting during the period covered by this report that could materially affect,
or are reasonably likely to materially affect, our financial reporting.



                                       28




                          ABRAXAS PETROLEUM CORPORATION

                                     PART II
                                OTHER INFORMATION

Item 1.    Legal Proceedings.

     There have been no changes in legal  proceedings from that described in the
Company's  Annual Report of Form 10-K for the year ended  December 31, 2005, and
in Note 7 in the Notes to Condensed  Consolidated Financial Statements contained
in Part I of this report on Form 10-Q.

Item 1A.   Risk Factors.

     In addition to the other  information set forth in this report,  you should
carefully  consider the factors  discussed in Part I, "Item 1A. Risk Factors" in
our Annual Report on Form 10-K for the year ended December 31, 2005, which could
materially affect our business, financial condition or future results. The risks
described  in our  Annual  Report  on Form  10-K are not the only  risks  facing
Abraxas. Additional risks and uncertainties not currently known to us or that we
currently  deem to be  immaterial  also  may  materially  adversely  affect  our
business, financial condition and/or operating results.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds.

            None


Item 3.    Defaults Upon Senior Securities.

           None

Item 4.    Submission of Matters to a Vote of Security Holders.


         None

Item 5.    Other Information.


         None

Item 6.    Exhibits.


         (a) Exhibits

         Exhibit 31.1 Certification - Robert L.G. Watson, CEO
         Exhibit 31.2 Certification - Chris E. Williford, CFO
         Exhibit 32.1 Certification  pursuant to 18 U.S.C. Section 1350 - Robert
         L.G. Watson, CEO
         Exhibit 32.2 Certification  pursuant to 18 U.S.C.  Section 1350 - Chris
         E. Williford, CFO










                                       29





                          ABRAXAS PETROLEUM CORPORATION

                                   SIGNATURES



     Pursuant to the  requirements  of the  Securities  Exchange Act of 1934, as
amended the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.




    Date:  November 6, 2006              By:/s/ Robert L.G. Watson
                                             --------------------------
                                           ROBERT L.G. WATSON,
                                           President and Chief
                                           Executive Officer


    Date:  November 6, 2006              By:/s/ Chris E. Williford
                                           -----------------------------
                                           CHRIS E. WILLIFORD,
                                           Executive Vice President and
                                           Principal Accounting Officer



                                       30
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