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

Forward Looking Statements

In addition to historical information contained herein, this discussion contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, subject to various risks and uncertainties that could cause our actual results to differ materially from those in the "forward-looking" statements. While we believe our forward looking statements are based upon reasonable assumptions, there are factors that are difficult to predict and that are influenced by economic and other conditions beyond our control. Investors are directed to consider such risks and other uncertainties discussed in documents filed by the company with the Securities and Exchange Commission.

Results of Operations

For the nine months ended September 30, 2009, we had a net loss of $2,014,612 compared to a net income of $1,206,261 during the first nine months of 2008, a $3,220,873 difference. Total revenues for the first nine months of 2009 were $4,780,283, a decrease of $7,878,863 or 62.2% from the total revenues of $12,659,146 during the period in 2008. This decrease in revenues was the result of decreases in oil and natural gas commodity prices affecting our oil and natural gas production revenues. The decline in revenues was also the result of lower turnkey drilling revenues due to lower direct working interest sales for the period in 2009. For the quarter ended September 30, 2009 our net loss was $828,825 compared to a net profit of $1,373,491, again as a result of lower oil and natural gas prices and lower turnkey drilling revenues.

In the first nine months of 2009, revenues from oil and gas production decreased $3,699,857 or 63.4% to $2,135,421 from 2008 revenues of $5,835,278, due to lower prices received for our oil and natural gas production. The net sales volume of natural gas for the nine months ended September 30, 2009, was approximately 460,675 Mcf with an average price of $3.96 per Mcf, versus 535,777 Mcf with an average price of $9.13 per Mcf for the first nine months of 2008. This represents a decrease in net sales volume of 75,102 Mcf or 14%, mainly due to the natural declines in production from existing wells. For the quarter ended September 30, 2009, we produced 137,885 Mcf with an average price of $3.94 per Mcf versus 158,323 Mcf produced during the same quarter in 2008 with an average price of $8.31 per Mcf, which represents a 20,438 Mcf or 12.9% decrease in net sales volume. The net sales volume for oil and condensate (natural gas liquids) was 6,403 barrels with an average price of $48.55 per barrel for the first nine months of 2009, compared to 9,029 barrels at an average price of $104.77 per barrel for the first nine months in 2008. This represents a decrease in net sales volume of 2,626 barrels, or 29.1%. For the third quarter of 2009, oil and condensate produced decreased 578 barrels, or 22%, from 2,623 barrels produced in 2008 to 2,045 barrels produced in the same period in 2009. This decrease was mainly due to the natural declines in production from existing wells.

Oil and natural gas lease operating expenses decreased by $723,459 or 38.9%, to $1,138,425 for the nine months ended September 30, 2009, from $1,861,884 for the same period in 2008. For the third quarter 2009, lease operating expenses decreased $231,657 or 39.3% over the same period in 2008. These decreases were mainly due to lower workover and plugging costs during the period in 2009. For the nine months ended September 30, 2009, turnkey drilling revenues decreased $4,064,292 or 64.8% to $2,205,253 from $6,269,545 during the same period in 2008. We also had a $2,032,993 or 69.5% decrease in turnkey drilling and development costs to $893,386 in 2009 from $2,926,379 in 2008. In the third quarter of 2009, turnkey drilling revenues decreased $2,621,030 or 86.9% from $3,016,909 during the period in 2008 to $395,879 in 2009. Also, during the second quarter in 2009 we had an adjustment to turnkey drilling costs of $334,150 on previously drilled wells due to lower than anticipated drilling costs. Turnkey drilling revenues decreased due to lower direct working interest sales for the period in 2009 due to the current economic downturn. Turnkey drilling costs decreased due to lower than anticipated costs on wells drilled during 2008 and 2009. In the fourth quarter, we have completed the drilling of one well and have begun drilling another well in California. We expect to drill approximately three to six additional California wells before the end of the year.

We periodically review our proved properties for impairment on a field-by-field basis and charge impairments of value to the expense. Impairment losses of $98,075 and $820,966 were recorded in the first nine months of 2009 and 2008, respectively. These impairments were mainly due to various lease and land costs that were no longer viable. Also during the periods in 2009 and 2008, we recorded a loss of $125,102 and a gain of $2,602,577, respectively, on the sales of non-oil and gas assets. The majority of the 2009 loss stems from the liquidation of our available for sale securities holdings. The gain from the same period in 2008 relates to the sale of our Rio Bravo field located in Kern County, California

The aggregate of supervisory fees and other income was $439,609 for the nine months ended September 30, 2009, a decrease of $114,714 (20.7%) from $554,323 during the same period in 2008. Third quarter supervisory fees and other income decreased $54,387, or 27.7%, to $141,923 from $196,310 in 2008. These decreases were due to lower interest income received on our available cash and to lower cost recovery fees on facilities due to lower natural gas production.

Depreciation, depletion and amortization expense decreased to $1,574,104 from $2,601,622, a decrease of $1,027,518 (39.5%) for the nine months ended September 30, 2009, as compared to the same period in 2008. This decrease in depletion expense was mainly due to the decrease in our oil and gas assets from our 2008 impairments.

General and administrative expenses decreased by $378,084 or 12.4%, from $3,041,235 for the nine months ended September 30, 2008, to $2,663,151 for the period in 2009. Third quarter 2009 general and administrative expense decreased $111,514, or 11% from $1,016,682 in 2008 compared to $905,168 in 2009. These decreases were primarily due to our cost control measures.

Marketing expense for the nine months ended September 30, 2009, decreased $266,439, or 29.1%, to $650,186, compared to $916,625 for the same period in 2008. For the third quarter, marketing expenses decreased $108,439, or 28.7%, to $269,166 from $377,605 for the same period in 2008. Marketing expense varies from period to period according to the number of marketing events attended by personnel and their associated costs.

Legal and accounting expense decreased to $657,281 for the first nine months of 2009, compared to $1,067,197 for same period in 2008, a $409,916 or 38.4% decrease. This decrease was a result of lower legal fees due to litigation defending property rights in 2008, which culminated in a trial and a successful outcome for the company in April of 2008. For the third quarter, legal and accounting expenses increased by $67,449, or 109.8% from the previous period last year. The increase in legal and accounting expense was a result of higher tax preparation fees.

Interest expense decreased to $79,624 for the three quarters ended September 30, 2009, from $195,408 for the same period in 2008, a $115,784, or 59.3% decrease. This was due to a decrease in the usage of our bank line of credit. For the same periods in 2009 and 2008, we also had income tax benefits of $1,286,843, an increase of $1,910,989 or 306.2% from an expense of $624,146 in 2008 as the result of operations moving from an income to loss position.

Bad debt expense for the first nine months ended September 30, 2009 was $202,404 and $172,839 for the third quarter of 2009. These expenses arose from identified uncollectable receivables relating to our oil and natural gas properties either plugged and abandoned or scheduled for plugging and abandonment. Approximately 78% of these expenses stem from one of our California wells. There were no bad debt expenses identified and recognized for the first nine months ended September 30, 2008.

Capital Resources and Liquidity

At September 30, 2009, Royale Energy had current assets totaling $6,010,981 and current liabilities totaling $10,889,090, for a $4,878,109 working capital deficit. We had cash and cash equivalents at September 30, 2009 of $1,767,393 compared to $1,330,739 at December 31, 2008.

During 2008, Royale Energy maintained a revolving credit agreement with Guaranty Bank, FSB, secured by all of our oil and gas properties, which at December 31, 2008, had outstanding indebtedness of $1,975,974. In February 2009, the Guaranty Bank loan was repaid and we entered into a new agreement with Texas Capital Bank, N.A. for a new revolving line of credit and letter of credit facility, also secured by our oil and gas properties, of up to $14,250,000 and separate letter of credit facility of up to $750,000, for the purposes of refinancing Royale's existing debt and to fund development, exploration and acquisition activities as well as other general corporate purposes. Under the terms of the agreement, Royale Energy may borrow, repay, and re-borrow funds as necessary. At September 30, 2009, we had a current borrowing base and outstanding indebtedness on this loan of $2,720,000.

At September 30, 2009, we were not in compliance with the current ratio financial covenant of our loan agreement with the bank, but we have obtained a waiver from the terms of that loan covenant. We are not in default on any principal, interest or sinking fund payment.

At September 30, 2009, our accounts receivable totaled $1,810,330, compared to $3,750,557 at December 31, 2008, a $1,940,227 (51.7%) decrease, primarily due to lower receivables from an industry member participating in wells we drilled at the end of 2008. At September 30, 2009, our accounts payable and accrued expenses totaled $5,636,452, a decrease of $4,683,735 or 45.4% from the accounts payable at December 31, 2008, of $10,320,187. This decrease was due to applying prepaid drilling remittances to trade accounts payable as aided by payments on other trade account payables.

On April 1, 2008, Nasdaq notified Royale that it was not in compliance with the requirement that companies listed on the Nasdaq Global Market are required by Marketplace Rule 4450(a)(3) to maintain a minimum of $10 million in stockholders' equity for continued listing. Effective July 31, 2009, Royale transferred its securities listing from the Nasdaq Global Market to the Nasdaq Capital Market. Royale complies with the Capital Market listing requirements. Royale does not believe that the transfer of its listing will have a material effect on the market for, or marketability of, its common stock.

Operating Activities. For the three quarters ended September 30, 2009, cash used by operating activities totaled $1,768,059 compared to operating activities providing $1,001,852 for the same period in 2008, a $2,769,911 or 276.5% decrease. This decrease in cash provided was due primarily to a decrease in our accounts payable and direct working interest sales during the period in 2009.

Investing Activities. For the first nine months ending September 30, 2009 and 2008, net cash provided by investing activities amounted to $117,223 and $582,899, respectively, a decrease of $465,676 or 80%. The difference stems from the sale of our Rio Bravo field during the third quarter of 2008. Capital acquisitions of oil and gas properties used $260,792 for the first nine months of 2009, compared to $4,885,213 for the same period in 2008, a $4,624,421 or a 94.7% decrease in cash used. This decreased capital acquisition was due to lower drilling expenditures during the period in 2009. During the third quarter of 2009, the Company liquidated all its Equity Securities. For the first nine months of 2009, its equity sales and purchases generated $330,545. However, for the first nine months of 2008, the Company's equity sales and purchases used $230,799.

Financing Activities. For the nine months ended September 30, 2009, cash provided by financing activities was $2,087,490 compared to $1,229,999 for the same period in 2008, a $857,491 difference. In the third quarter of 2009 and second quarter of 2008 we received net proceeds of $1,288,464 and $3,724,999 from the sale of common stock and warrants to one investor in a private placement. The proceeds were used to reduce long term debt and for working capital. Moreover, in the first quarter of 2009, we paid off our line of credit with Guaranty Bank and established a new one with Texas Capital Bank.