HYDROCARB ENERGY CORP - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - HYDROCARB ENERGY CORP	Financial_Report.xls
EX-31.1 - EXHIBIT 31.1 - HYDROCARB ENERGY CORP	ex31_1.htm
EX-32.1 - EXHIBIT 32.1 - HYDROCARB ENERGY CORP	ex32_1.htm
EX-31.2 - EXHIBIT 31.2 - HYDROCARB ENERGY CORP	ex31_2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934: For the quarterly period ended January 31, 2012

o	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: 000-53313

STRATEGIC AMERICAN OIL CORPORATION

(Exact name of registrant as specified in its charter)

NEVADA		98-0454144
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

800 Gessner, Suite 200

Houston, Texas 77024

(Address of principal executive offices, including zip code)

361-884-7474

(registrant’s principal executive office telephone number)

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 such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x Noo

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

Large accelerated filer o		Accelerated filer o

Non-accelerated filer o		Smaller reporting company x
(Do not check if a smaller reporting company)

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

As of March 16, 2012, 269,742,986 shares of common stock, $0.001 par value, were outstanding.

Table of Contents

Part I. Financial Information

Item 1. Financial Statements	3

Item 2. Management’s Discussion and Analysis of Financial Condition and Results Of Operations	17

Item 3. Quantitative and Qualitative Disclosures About Market Risk	23

Item 4. Controls and Procedures	23

Part II. Other Information

Item 1. Legal Proceedings	23

Item 1A. Risk Factors	23

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	23

Item 3. Defaults Upon Senior Securities	23

Item 4. (Removed and Reserved)	24

Item 5. Other Information	24

Item 6. Exhibits	24

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Part I. Financial Information

Item 1. Financial Statements

1. Consolidated Balance Sheets (unaudited)

2. Consolidated Statements of Operations and Comprehensive Income (unaudited)

3. Consolidated Statements of Cash Flows (unaudited)

4. Notes to Consolidated Financial Statements (unaudited)

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STRATEGIC AMERICAN OIL CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	January 31, 2012			July 31, 2011
Assets
Current assets
Cash and cash equivalents	$	3,073,078		$	1,082,099
Oil and gas revenues receivable		520,876			875,918
Accounts receivable – related party		100,963			69,880
Available for sale securities		1,079,524			-
Other receivables, net		40,176			225,057
Other current assets		964,840			292,973
Total current assets		5,779,457			2,545,927

Oil and Gas Property, accounted for using the full cost method of accounting
Evaluated property, net of accumulated depletion of $945,739 and $567,189, respectively; and accumulated impairment of $373,335 and $373,335, respectively		11,500,874			7,395,198
Unevaluated property		37,120			-
Restricted cash		6,650,000			6,716,850
Other assets		338,085			255,942
Property and equipment, net of accumulated depreciation of $24,451 and $11,158, respectively		46,145			22,857

Total Assets	$	24,351,681		$	16,936,774

Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable and accrued expenses	$	2,398,802		$	1,676,816
Line of credit		-			1,360,573
Notes payable		-			255,596
Advances		1,438,679			-
Asset retirement obligations – short term		648,396			468,500
Derivative warrant liability		1,557,392			2,543,223
Due to related parties		-			14,723
Total current liabilities		6,043,269			6,319,431

Asset retirement obligations – long term		5,553,920			3,987,428
Total liabilities		11,597,189			10,306,859

Stockholders’ equity:
Common stock, $.001 par; 500,000,000 shares authorized shares; 269,836,317 and 169,770,770 shares issued and outstanding		269,836			169,771
Additional paid in capital		38,336,554			27,807,540
Accumulated other comprehensive loss		(13,434)			-
Accumulated deficit		(25,838,464	)		(21,347,396	)
Total stockholders’ equity		12,754,492			6,629,915

Total liabilities and stockholders’ equity	$	24,351,681		$	16,936,774

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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STRATEGIC AMERICAN OIL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

	Three months ended January 31,						Six months ended January 31,
	2012			2011			2012			2011

Revenues	$	1,839,961		$	116,261		$	3,402,840		$	229,134

Operating expenses
Lease operating expense		1,062,202			39,124			1,867,574			140,388
Depreciation, depletion, and amortization		213,833			28,925			391,843			51,925
Accretion		145,912			1,270			283,794			3,664
Impairment		-			140,029			-			140,029
Consulting fees – related party		44,856			-			92,613			-
Acquisition cost – related party		-			-			4,367,750			-
Other general and administrative expense		928,787			378,006			2,336,840			1,218,719
Total operating expenses		2,395,590			587,354			9,340,414			1,554,725

Loss from operations		(555,629	)		(471,093	)		(5,937,574	)		(1,325,591	)

Interest income (expense), net		(35,182	)		11,806			(102,676	)		(14,779	)
Gain (loss) on derivative warrant liability		126,803			(191,988	)		985,831			(276,549	)
Gain on sale of available for sale securities		-			-			433,168			-
Net loss before income taxes		(464,008	)		(651,275	)		(4,621,251	)		(1,616,919	)
Income tax benefit		172,131			-			130,183			-
Net Loss	$	(291,877	)	$	(651,275	)	$	(4,491,068	)	$	(1,616,919	)
Other comprehensive income, net of tax:
Net unrealized loss from available for sale securities, net of income tax benefit of $32,443, $0, $0 and $0 respectively		(73,685	)		-			(13,434	)		-

Comprehensive Loss	$	(365,562	)	$	(651,275	)	$	(4,504,502	)	$	(1,616,919	)

Basic and diluted loss per common share	$	(0.00	)	$	(0.01	)	$	(0.02	)	$	(0.03	)

Weighted average shares outstanding (basic and diluted)		269,708,784			53,601,127			241,317,016			53,408,220

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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STRATEGIC AMERICAN OIL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Six months ended January 31,
	2012			2011
Cash Flows From Operating Activities
Net loss	$	(4,491,068	)	$	(1,616,919	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation, depletion and amortization		391,843			51,925
Impairment		-			140,029
Accretion		283,794			3,664
Change in deferred taxes		(130,200)			-
Amortization of debt discount		-			3,886
Amortization of loan origination fees and prepaid interest expense		73,761			-
Gain on sale of available for sale securities		(433,168	)		-
Warrants amortization – related party		92,613			-
Common stock granted for services and for investor relations		620,156			62,008
Share based compensation – amortization of the fair value of stock options		416,310			158,559
Acquisition cost – related party		4,367,750			-
(Gain) loss on warrant derivative liability		(985,831	)		276,549
Changes in operating assets and liabilities:
Accounts receivable		539,923			7,898
Accounts receivable – related party		(31,083	)		(23,924)
Accounts payable and accrued expenses		(825,015	)		36,505
Advances		834,861			-
Other assets		8,449			251,328
Net cash provided by (used in) operating activities		733,095			(648,492	)

Cash Flows From Investing Activities
Purchases of oil and gas properties		(351,132	)		(229,956	)
Purchases of property and equipment		(36,581	)		-
Proceeds from sale of oil and gas properties		-			275,000
Change in restricted cash		54,946			-
Purchase of available for sale securities		(702,958	)		-
Proceeds from sale of available for sale securities		3,943,168			-
Net cash provided by investment activities		2,907,443			45,044

Cash Flows From Financing Activities
Proceeds from sales of common stock		-			200,100
Proceeds from notes payable		-			45,000
Payments on notes payable		(1,634,836	)		(85,000	)
Payments on notes payable – related party		(14,723	)		203,300
Net cash provided by (used in) financing activities		(1,649,559	)		363,400

Net increase (decrease) in cash		1,990,979			(240,048	)
Cash at beginning of period		1,082,099			247,851
Cash at end of period	$	3,073,078		$	7,803

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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STRATEGIC AMERICAN OIL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(Unaudited)

	Six months ended January 31,
	2012		2011

Supplemental Disclosures:
Interest paid in cash	$	35,874	$	-
Income taxes paid in cash		-		-

Non-cash investing and financing
Non-cash capitalized interest	$	-	$	41,550
Asset retirement obligation sold		32,772		50,907
Asset retirement obligations incurred		1,389		-
Exercise of warrants classified as a derivative		-		153,445
Notes receivable for sale of oil and gas properties		-		100,000
Acquisition of SPE Navigation I, LLC for Strategic common stock, including asset retirement obligation assumed of $1,493,977		5,132,250		-
Accounts payable for oil and gas properties		221,356		-
Notes payable for prepaid insurance		18,667		-
Adjustment of purchase price of acquisition: environmental liability acquired		112,500		-
Unrealized loss on available for sale securities, net of tax benefit		13,434		-

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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STRATEGIC AMERICAN OIL CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 - Basis of presentation

The unaudited consolidated financial statements of Strategic American Oil Corporation (“Strategic”, the “Company”, “we”, “us”, “our”) have been prepared in accordance with accounting principles generally accepted in the United States and the rules of the Securities and Exchange Commission (“SEC”), and should be read in conjunction with the audited financial statements and notes thereto contained in our Annual Report filed with the SEC on Form 10-K for the year ended July 31, 2011. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position and the results of operations for the interim periods presented have been reflected herein. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Notes to the financial statements which would substantially duplicate the disclosures contained in the audited financial statements for the most recent fiscal year ended July 31, 2011, as reported in the Form 10-K, have been omitted.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Strategic and our wholly owned subsidiaries, Penasco Petroleum Corporation (“Penasco”), SPE Navigation I, LLC (“SPE”) and Galveston Bay Energy, LLC (“GBE”). All significant intercompany accounts and transactions have been eliminated in consolidation.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current presentation.

Available for sale securities

We invest in marketable equity securities which are classified as available for sale. Available-for-sale securities are marked to market based on the fair values of the securities determined in accordance with ASC Section 820 (Fair Value Measurement), with the unrealized gains and losses, net of tax, reported as a component of Accumulated other comprehensive income (loss).

Restricted cash

Restricted cash consists of certificate of deposits that have been posted as collateral supporting a reclamation bond guaranteeing remediation of our oil and gas properties in Texas. As of January 31, 2012 and July 31, 2011, respectively, restricted cash totaled $6,650,000 and $6,716,850. During the period ended January 31, 2012, the bond requirement reduced and accordingly, $66,850 of restricted cash was released to us. The paying bank deducted $11,904 of outstanding interest payable and we received a net release of $54,946.

Advances

Advances consist of prepayments received from working interest partners pertaining to their share of the costs of drilling oil and gas wells. Partners are billed in advance for the estimated cost to drill a well and as the work proceeds, the prepayment is applied against their share of the actual drilling cost.

Earnings per share

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of common and potential common shares outstanding during the period. There were no potential common shares outstanding during the three and six months ended January 31, 2012 and 2011 and, therefore, basic and diluted net income per common share are the same.

Comprehensive Income

Comprehensive income consists of net income (loss) and other gains and losses affecting stockholders’ equity that, under accounting principles generally accepted in the United States, are excluded from net income (loss). Unrealized loss on available for sale securities, net of taxes, of $13,434 is included in Accumulated other comprehensive income (loss).

Recently issued or adopted accounting pronouncements

Recently issued or adopted accounting pronouncements are not expected to have, or did not have, a material impact on our financial position or results from operations.

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Note 2 - Acquisitions

Galveston Bay Energy, LLC

On February 15, 2011 we closed on the acquisition of a private Texas oil and gas company named Galveston Bay Energy, LLC (“GBE”) which owns working interests in and operates producing oil and natural gas properties and its related facilities in four fields located in Galveston Bay, Texas. Immediately following our acquisition of GBE, we sold 15% of our own aggregate working interest in the Galveston Bay fields for $1,400,000 in cash to SPE Navigation 1, LLC (“SPE”), a company controlled by Michael Watts, who is the father-in-law of Jeremy Driver, a Director and our Chief Executive Officer. Our agreement with SPE provided that SPE could acquire an additional 10% working interest in the properties for $1,150,000 paid within 90 days of the acquisition. Effective May 1, 2011, SPE acquired an additional 10% of our aggregate working interest in the Galveston Bay fields for an additional $1,150,000 pursuant to our agreement.

During the six months ended January 31, 2012, we determined that we could estimate a range of potential loss associated with an environmental liability at one of the properties we acquired when we acquired GBE (See Note 11 – Commitments and Contingencies). We adjusted the purchase price allocation for the purchase by increasing accounts payable acquired and oil and gas properties acquired by the amount that we recognized, $112,500 ($37,500 of the cost was recognized with the acquisition of SPE). The adjustment did not change the identifiable net assets acquired.

SPE Navigation I, LLC

On September 23, 2011, Strategic acquired SPE, which owned 25% of the working interest in the oil and gas properties originally owned by Galveston Bay Energy, LLC and 1,000,000 shares of Hyperdynamics Corporation, a public company traded on the New York Stock Exchange (NYSE:HDY). The total purchase price consisted of 95,000,000 shares of Strategic’s common stock. We acquired 100% of the membership interest in SPE and thus SPE is our wholly owned subsidiary.

As of the acquisition date, the working interests previously owned by SPE were conveyed to GBE. Thus, all oil and gas revenues after the SPE acquisition were attributed to GBE. Our consolidated statements include the results of the 100% acquired working interest.

The transaction was a related party transaction because SPE was owned by companies controlled by our CEO, his brother-in-law, and his sister-in-law, and SPE was managed by our CEO’s father-in-law. The purchase price was calculated as $9,500,000, based on the quoted market price of our stock on the date of the acquisition. The assets and liabilities were recorded at SPE’s carrying value on the date of the acquisition and the excess purchase price over the net assets acquired was $4,367,750, which was recorded as compensation expense because this was a related party transaction. The transaction is intended to be structured, for tax purposes, as a tax-free merger, and as such, Strategic would assume a carry-over basis in SPE’s assets. Consequently, a deferred tax liability was established.

The following table summarizes the preliminary allocation of the purchase price to the assets acquired and liabilities assumed at the acquisition date:

Recognized Amount of Identifiable Assets Acquired and Liabilities Assumed

Available for sale securities (1)	$	3,900,000
Oil and Gas Property, accounted for using the full cost basis of accounting Evaluated property (2)		4,081,477
Accounts payable and accrued expenses		(37,500	)
Deferred tax liability (1)		(1,317,750	)
Asset retirement obligations (2)		(1,493,977	)
Total Identifiable Net Assets	$	5,132,250

(1)

The Hyperdynamics common stock is valued, using the closing market price on the acquisition date, at $3.90 per share. SPE management believes its tax basis in Hyperdynamics common stock is $0.135 per share. Deferred taxes, therefore, are computed on the difference between the tax basis and the book basis per share at the corporate tax rate of 35%. If the carry-over basis is not available to Strategic, there would be no book tax difference and no deferred taxes associated with the acquisition. If that occurs, the identifiable net assets would be $6,450,000 and there would be no deferred tax liability acquired.

(2)

Oil and gas properties include the asset retirement obligation measured on the effective date of the transaction at $1,493,977 and $2,550,000, which was the cash price that SPE paid to obtain its 25% working interest in the oil and gas properties and represents the fair value of the properties.

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Supplemental pro forma information

The unaudited pro forma results presented below for the three and six months ended January 31, 2012 and 2011 have been prepared to give effect to the purchases described above as if they had been consummated on August 1, 2009. The unaudited pro forma results do not purport to represent what our results of operations actually would have been if the acquisitions had been completed on such date or to project our results of operations for any future date or period.

	Three months ended January 31,						Six months ended January 31,
	2012			2011			2012			2011
Revenues	$	1,839,961		$	1,013,477		$	3,550,839		$	2,558,844
Loss from operations		(555,629	)		(1,093,138	)		(6,128,510	)		(2,572,252	)
Net loss		(291,877	)		(1,273,320	)		(4,682,004	)		(2,863,580	)
Earnings per share, basic and diluted	$	(0.00	)	$	(0.00	)		(0.02	)		(0.01	)

Note 3 – Available for Sale Securities

Beginning in the quarter ended October 31, 2011, we owned marketable equity securities, which are classified as available for sale.

The cost, unrealized gains (loss), and fair value of available for sale securities at January 31, 2012 were as follows:

Cost	$	1,092,958
Unrealized loss		(13,434	)
Fair Value	$	1,079,524

We have no securities that have been in an unrealized loss position for longer than 12 months.

We acquired securities with a market value of $3,900,000 in conjunction with our acquisition of SPE. (See Note 2 – Acquisitions) During the six months ended January 31, 2012, we received cash proceeds of $3,943,168 from sales of securities with a cost basis of $3,510,000; thus, we had a realized gain on sale of available for sale securities of $433,168. During the six months ended January 31, 2012, we purchased securities at a market price of $702,958. We had no reclassifications from accumulated other comprehensive income to net income during the period. Available for sale securities are re-measured at fair value at every reporting date. (See Note 8 – Fair Value)

Note 4 - Oil and Gas Properties

Oil and natural gas properties as of January 31, 2012 and July 31, 2011 consisted of the following:


	January 31, 2012			July 31, 2011
Oil and gas properties
Evaluated Properties:

Costs subject to depletion	$	12,446,613		$	7,962,387

Depletion		(945,739	)		(567,189	)
		11,500,874			7,395,198
Unevaluated Properties:		37,120			-
Total oil and gas properties	$	11,537,994		$	7,395,198

Evaluated property

Significant additions to oil and gas properties during the six months ended January 31, 2012 include:

●

The acquisition of an aggregate of approximately 25% working interest in our properties in Galveston Bay as part of our acquisition of SPE, as discussed in Note 2 – Acquisitions, for $4,081,477, which includes asset retirement obligations assumed of $1,493,977;

●

Adjustment of $112,500 to the purchase price of GBE to reflect recognition of an estimate of the cost of soil remediation required to be completed at one of GBE’s facilities. The remediation liability existed as of the date of acquisition;

●

Land acquisition costs of $13,992;

●

Exploration costs, consisting primarily of geological and geophysical costs, of $87,165; and

●

Development costs of $221,864 which consists primarily of $67,477 expended on a recompletion of one of our Welder wells onshore in South Texas and $153,885 expended on a new drill to access proved undeveloped reserves offshore in Galveston Bay.

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In September 2011, the operator in our Markham City, Illinois project area commenced drilling of three wells, which were completed during the six months ended January 31, 2012. We are currently producing oil in the project area. As of January 31, 2012, the operator had expended approximately $1,061,000 towards the Earnings Threshold. In accordance with our farmout agreement, we will be required to contribute our 10% working interest share toward development of the area after the Earnings Threshold, $1,350,000, has been met. We are currently responsible for our 10% working interest pertaining to routine operational expenses for completed wells. In February 2012, the operator commenced a pilot water flood project to re-pressurize the reservoir and enhance recovery of oil from the area.

In January 2012, we sold half of our working interest in the development well in Galveston Bay to several parties who assumed their share of costs and expenses. After the sale, we owned a 25% interest in the well. In January 2012, we sold our 100% working interest in an onshore well. The buyer assumed the asset retirement obligation for the well, $32,772. We received no cash proceeds in conjunction with either sale. The assumed asset retirement obligation was the only consideration we received for these transactions. In accordance with full cost rules, we recognized no gain or loss on the sales.

Unevaluated property

In September 2011, we purchased a non-operated working interest in mineral leases covering 460 acres onshore in Duval County, Texas. Under the agreement, the operator commenced drilling a well, the Palacios #1, during November 2011. Our working interest in the lease area is 6.70732% to the casing point of the first well drilled and 5.5% after the casing point of the initial well and for subsequent operations in the lease area. Our net revenue interest in the prospect is 4.125%. The operator commenced drilling of an exploratory well, Palacios #1, within the prospect area in November 2011. We have expended $37,120 on this project as of January 31, 2012. We have elected to participate in the completion and have paid completion costs of $12,463, which is carried as a prepaid expense. We are still in the process of completing the well. An additional cash call of $3,685 was paid in February 2012.

Impairment

We account for our oil and natural gas producing activities using the full cost method of accounting as prescribed by the United States Securities and Exchange Commission (SEC). Under this method, subject to a limitation based on estimated value, all costs incurred in the acquisition, exploration, and development of proved oil and natural gas properties, including internal costs directly associated with acquisition, exploration, and development activities, the costs of abandoned properties, dry holes, geophysical costs, and annual lease rentals are capitalized within a cost center.

We evaluated our capitalized costs using the full cost ceiling test as prescribed by the Securities and Exchange Commission at January 31, 2012 and July 31, 2011. At January 31, 2012 and July 31, 2011, our net book value of oil and gas properties did not exceed the ceiling amount and thus, there was no impairment.

Changes in production rates, levels of reserves, future development costs, and other factors will determine our actual ceiling test calculation and impairment analyses in future periods.

Note 5 - Asset Retirement Obligation

The following is a reconciliation of our asset retirement obligation liability as of January 31, 2012 and July 31, 2011:

	January 31, 2012			July 31, 2011
Liability for asset retirement obligation, beginning of period	$	4,455,928		$	57,623
Asset retirement obligations assumed		1,493,977			5,843,330
Asset retirement obligations sold		(32,772	)		(1,523,573	)
Asset retirement obligations incurred		1,389			-
Accretion		283,794			213,866
Costs incurred		-			(135,318	)
Liability for asset retirement obligation, end of period	$	6,202,316		$	4,455,928

Note 6 - Line of Credit

On March 17, 2011, GBE secured a one year revolving line of credit of up to $5,000,000 with a commercial bank. The note carries interest at a rate of prime + 1% (currently 6%) with a minimum interest rate of 5%. Interest is payable monthly. The note is collateralized by our Galveston Bay properties and substantially all of GBE’s assets. Strategic has also executed a parental guarantee of payment.

During the six months ended January 31, 2012 we had repaid $1,360,573 amounts outstanding on the line of credit. Thus, there were no amounts outstanding and the entire amount of the line of credit, $5,000,000, was available as of January 31, 2012.

We incurred $64,151 of loan origination fees which are being amortized straight line over one year, the term of the loan. As of January 31, 2012, $56,133 had been amortized.

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Note 7 - Notes Payable

In November 2011, we paid $6,423 principal on a note payable due to a director and the associated accrued interest.

In October 2011, we paid $8,300 of principal on a note payable due to an officer and director of Strategic

During the six months ended January 31, 2012, we modified our insurance coverage and financed $18,667 of the premium due attributable to the endorsement. We also paid the remaining installments for our insurance financing arrangement during the period.

During November 2011, we paid off the $175,000 note payable due to one of our former directors.

Accordingly, as of January 31, 2012, we had no notes payable outstanding.

Note 8 - Fair Value

Accounting standards regarding fair value of financial instruments define fair value, establish a three-level hierarchy which prioritizes and defines the types of inputs used to measure fair value, and establish disclosure requirements for assets and liabilities presented at fair value on the consolidated balance sheets.

Fair value is the amount that would be received from the sale of an asset or paid for the transfer of a liability in an orderly transaction between market participants. A liability is quantified at the price it would take to transfer the liability to a new obligor, not at the amount that would be paid to settle the liability with the creditor.

The three-level hierarchy is as follows:

●

Level 1 inputs consist of unadjusted quoted prices for identical instruments in active markets.

●

Level 2 inputs consist of quoted prices for similar instruments.

●

Level 3 valuations are derived from inputs which are significant and unobservable and have the lowest priority.

The following table sets forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of January 31, 2012.

	Carrying Value at January 31,		Fair Value Measurement at January 31, 2012
	2012		Level 1		Level 2		Level 3
Assets:
Available for sale securities	$	1,079,524	$	1,079,524		-		-

Liabilities:
Derivative warrant liability	$	1,557,392		-		-	$	1,557,392

The carrying amounts reported in the balance sheet for cash, accounts receivable, accounts receivable – related party, accounts payable and accrued expenses, and notes payable approximate their fair market value based on the short-term maturity of these instruments.

Note 9 – Warrant Derivative Liability

Effective July 31, 2009, we adopted FASB ASC Topic No. 815-40 (formerly EITF 07-05) which defines determining whether an instrument (or embedded feature) is indexed to an entity’s own stock. This literature specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to our own stock and (b) classified in stockholders’ equity in the statement of financial position, would not be considered a derivative financial instrument and provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the scope exception.

Certain warrants we issued during the year ended July 31, 2010 are not afforded equity treatment because these warrants have a down-round ratchet provision on the exercise price. As a result, the warrants are not considered indexed to our own stock, and as such, the fair value of the embedded derivative liability is reflected on the balance sheet and all future changes in the fair value of these warrants will be recognized currently in earnings in our consolidated statement of operations under the caption “Gain (loss) on warrant derivative liability” until such time as the warrants are exercised or expire. The total fair values of the warrants issued during the year ended July 31, 2010, were determined using a lattice model and have been recognized as a derivative liability as described below.

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The warrants were valued using a multi-nomial lattice model with the following assumptions:

●

Warrant holders would exercise at target price multiples of the market price trigger prices. The target price multiple reduces as the warrants approach maturity;

●

Warrant holders would exercise the warrant at maturity if the stock price was above two times the reset exercise price;

●

An annual reset event would occur at 65% discount to market price;

●

The projected volatility was based on historical volatility. Because we do not have sufficient trading history to determine our own historical volatility, we used the volatility of a group of comparable companies combined with our own historical volatility from May 2009, when we began trading.

The following table sets forth the changes in the fair value measurement of our Level 3 derivative warrant liability during the six months ended January 31, 2012:

Beginning balance – August 1, 2011	$	2,543,223

Change in fair value of derivative liability		(985,831	)

At January 31, 2012	$	1,557,392

The $985,831 change in fair value was recorded as a reduction of the derivative liability and as an unrealized gain on the change in fair value of the liability in our statement of operations.

Note10 – Stockholders’ Equity

Common Stock Issuances

During December 2011 we granted 325,917 shares of common stock as compensation for services valued at $27,703. The shares were valued using the closing market price on the date of the grant.

During August 2011, we granted 4,739,630 shares of common stock to certain investors who had participated in our October and November 2009 equity raises, and as a consequence owned derivative warrants. These investors had exercised some of their warrants prior to our equity raise in February 2011, which triggered the down-round ratchet provision in the warrants. The warrant contracts specify that the ratchet adjustment is not made for warrants that were exercised prior to the repricing event. As a consequence of their warrant exercises, they had forfeited their contractual right to receive ratchet warrant shares. However, management granted stock to these investors as a goodwill gesture. The stock grant was treated as an investor relations expense and valued at $592,453. The shares were valued using the closing market price on the date of grant.

During September 2011, we issued 95,000,000 million shares to the members of SPE Navigation I, LLC towards acquisition of SPE. The purchase price was calculated as $9,500,000, based on the quoted market price of our stock on the date of the acquisition. (See Note 2 - Acquisitions).

Stock Options and Warrants

Strategic may grant up to 40,000,000 shares of common stock under several historical stock-based compensation plans (the “Plans”). During April 2011, the Board of Directors authorized and approved the adoption of the 2011 Stock Incentive Plan (the “2011 Plan”). An aggregate of 25,000,000 shares of our common stock may be issued under the 2011 Plan. During August 2010, the Board of Directors authorized and approved the adoption of the 2010 Stock Incentive Plan (the “2010 Plan”). An aggregate of 5,000,000 shares of our common stock may be issued under the 2010 Plan. An aggregate of 10,000,000 of our shares may be issued under the 2009 Re-Stated Stock Incentive Plan (the “2009 Plan”). The Plans are administered by the Board of Directors which has substantial discretion to determine persons, amounts, time, price, exercise terms, and restrictions of the grants, if any.

There were no options grants during the six month period ended January 31, 2012.

Options granted to non-employees

The following table provides information about options granted to consultants under our stock incentive plans during the six months ended January 31, 2012 and 2011:

	2012		2011
Number of options granted		-		1,400,000
Compensation expense recognized	$	281,568	$	158,599
Compensation cost capitalized		-		-
Weighted average fair value of options granted		-	$	0.14

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For the options on a graded vesting schedule, we estimate the fair value of the award, using the Black-Sholes option pricing method, as of the end of each reporting period and recognize an appropriate portion of the cost based on the fair value on that date. When the award vests, we adjust the cost previously recognized so that the cost ultimately recognized is equivalent to the fair value on the date the performance is complete. Based on the fair value of the options as of January 31, 2012 there was $815,243 of unrecognized compensation cost related to non-vested share based compensation arrangements granted to non-employees.

The following table details the significant assumptions used to compute the fair market values of stock option expense associated with options granted to non-employees during the six months ended January 31, 2012 and 2011:

	2012	2011
Risk-free interest rate	0.13-1.24%	0.51 - 1.27%
Dividend yield	0%	0%
Volatility factor	137.10 – 145.47%	134.62 - 153%
Expected life (years)	1 - 6.5 years	1.5 – 5 years

Options granted to employees

We granted no options to employees during the six months ended January 31, 2012 and 2011. We recognized $134,742 of compensation expense associated with the amortization of options that were granted to employees in April 2011. As of January 31, 2012, there was $443,178 of unrecognized compensation cost associated with these options.

Summary information regarding all stock options issued and outstanding as of January 31, 2012 is as follows:

	Options		Weighted Average Share Price		Aggregate intrinsic value		Weighted average remaining contractual life (years)
Outstanding at year ended July 31, 2011		27,530,000	$	0.10	$	1,101,200		8.14
Granted		-		-
Exercised		-		-
Expired		-		-
Outstanding at January 31, 2012		27,530,000	$	0.10	$	-		7.64

Warrants

Summary information regarding stock warrants issued and outstanding as of January 31, 2012 is as follows:

	Warrants			Weighted Average Share Price		Aggregate intrinsic value		Weighted average remaining contractual life (years)

Outstanding at year ended July 31, 2011		93,961,497		$	0.10	$	3,710,880		3.83

Granted		-			-

Exercised		-			-

Expired		(50,000	)		1.00

Outstanding at January 31,2012		93,911,497		$	0.10	$	-		3.22

On February 15, 2011, we entered into a consulting agreement with Geoserve Marketing, LLC (“Geoserve”), a company controlled by Michael Watts, who is the father-in-law of Jeremy Driver, a Director and our Chief Executive Officer. In conjunction with the agreement, we granted warrants to purchase 30,000,000 shares of common stock that vest solely upon achievement of a market condition. If our common stock attains a five day average closing price of $.30 per share, an additional 15,000,000 warrants with an exercise price of $.10 and an expiration date of February 15, 2016 shall be issued. If our common stock attains a five day average closing price of $.60 per share, an additional 15,000,000 warrants with an exercise price of $.10 and an expiration date of February 15, 2016 shall be issued.

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The fair value of warrants that vest upon the attainment of a market condition must be estimated and amortized over the lower of the implicit or derived service period of the warrants. The fair value of the warrants and the derived service period were valued using a lattice model that values the liability of the warrants based on a probability weighted discounted cash flow model. This model is based on future projections of the various potential outcomes. The warrants to purchase 15,000,000 shares of common stock at $.30 per share and 15,000,000 shares of common stock at $.60 per share will be amortized over the derived service periods of 2.08 years and 2.49 years, respectively. As of January 31, 2012, the fair value of the warrants to purchase 15,000,000 shares of common stock at $.30 per share was $204,372 and the fair value of the warrants to purchase 15,000,000 shares at $.60 per share was $201,745. We recognized $92,613 of expense associated with these warrants during the six months ended January 31, 2012.

Note 11 – Commitments and Contingencies

We are subject to various federal, state and local laws and regulations relating to the discharge of materials into, and protection of, the environment as an owner or lessee and operator of oil and gas properties. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution clean-up resulting from operations and subject the lessee to liability for pollution damages. In some instances, we may be directed to suspend or cease operations in the affected area. We maintain insurance coverage, which we believe is customary in the industry, although we are not fully insured against all environmental risks.

There is soil contamination at a tank facility owned by GBE. As of July 31, 2011, we had determined that it was probable that remediation would be required and we were evaluating the extent of the contamination, the activities that will be required to perform the remediation, and whether the former owner would be required to assume the remediation. As of July 31, 2011, we concluded that the cost of the remediation was not estimable and, accordingly, it had not been reflected in our financial results.

During the six months ended January 31, 2012, we continued evaluation of the site and concluded that we could reasonably estimate a range of potential cost. Depending on the technique used to perform the remediation, we estimate the cost range to be between $150,000 and $500,000. We cannot determine a most likely scenario, thus we have recognized the lower end of the range. $150,000 has been recognized and is included in the balance sheet caption Accounts payable and accrued expenses. Because the liability was acquired with the acquisitions, we have adjusted the cost of acquired oil and gas properties to reflect the estimate of loss.

Oil and gas operators in the State of Texas are required to obtain a letter of credit in favor of the Railroad Commission of Texas as security that they will meet their obligations to plug and abandon the wells they operate. We have a letter of credit in the amount of $6,650,000 issued by Green Bank. We pay a 1.5% per annum fee in conjunction with this letter of credit. The fee, $99,400 was prepaid in June 2011 and is being amortized on a straight line basis through the letter of credit’s renewal in October 2012. As of January 31, 2012, $46,387 had been amortized.

Note 12 – Related Party Transactions

A company controlled by one of our officers operates our Barge Canal properties. The following table summarizes the activity associated with the Barge Canal properties:

	Three months ended January 31,				Six months ended January 31,
	2012		2011		2012		2011
Revenues	$	185,575	$	114,358	$	275,881	$	181,859
Lease operating costs	$	44,254	$	37,840	$	91,123		87,420

As of January 31, 2012 and July 31, 2011 respectively, we had outstanding accounts receivable associated with these properties of $100,963 and $69,880 and no accounts payable.

In November 2011, we paid $6,423 principal on a note payable due to a director. We also paid the associated accrued interest of $416.

In October 2011, we paid $8,300 of principal on a note payable due to an officer and director of Strategic. We also paid the accrued interest associated with the note of $413.

On September 23, 2011, we purchased SPE Navigation I, LLC, as more fully discussed in Note 2 – Acquisitions, with 95,000,000 shares of Strategic American common stock. The owners of SPE were companies owned by the CEO of Strategic, his brother-in-law, and his sister-in-law. Because the purchase price, $9,500,000, as computed using the fair value of the 95,000,000 shares on the date of purchase, exceeded the net assets acquired, we recognized compensation expense on the excess, $4,367,750. (See Note 2 - Acquisitions).

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We entered into a consulting contract with a company controlled by the father-in-law of our CEO, Michael Watts, in February 2011. Under the contract, Mr. Watts will provide investor relations services. Mr. Watts received warrants to purchase 20,000,000 shares of Strategic common stock at $.10 per share exercisable through February 2016 upon execution of the contract. Additionally, he received warrants to purchase 30,000,000 shares of Strategic common stock at $.10 per share, which expire in February 2016. The warrants vest if our common stock achieves certain market prices. The compensation cost is determined using a lattice model as discussed in Note 10 – Stockholders’ Equity. During the six months ended January 31, 2012, we recognized $92,613 of compensation cost associated with these warrants.

Note 13 – Subsequent Events

In February 2012, we entered into a premium financing arrangement to pay principal of $183,610 in conjunction with our commercial insurance program renewal. We are obligated to make nine payments of $20,487 per month, which include principal and interest, beginning in March 2012.

In February 2012, we purchased a non-operated working interest in mineral leases covering 200 acres onshore in Hardeman County, Texas. The operator had commenced drilling in the area on January 28, 2012. Our working interest in the lease area is 13.3% to the casing point of the first well drilled and 10.0% after the casing point of the initial well and for subsequent operations in the lease area. Our net revenue interest in the prospect is 7.50%. The well encountered no natural fracturing in the native limestone of the target geological formation which greatly limited the productivity of oil in the well. All parties chose to abandon and plug the well. We incurred approximately $90,000 of costs associated with the acquisition of this property and the drilling of the well. We are evaluating further development opportunities in the field, including horizontal drilling.

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CAUTIONARY STATEMENT ON FORWARD-LOOKING INFORMATION

The Company is including the following cautionary statement to make applicable and take advantage of the safe harbor provision of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company. This quarterly report on Form 10-Q contains “forward looking statements” (as that term is defined in Section 27A(i)(1) of the Securities Act of 1933), including statements concerning plans, objectives, goals, strategies, expectations, future events or performance and underlying assumptions and other statements which are other than statements of historical facts. Such forward looking statements involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward looking statements. Some of the factors that could cause actual results to differ materially from those expressed in such forward looking statements are set forth in the section entitled “Risk Factors” and elsewhere throughout this Form 10-Q. Our expectations, beliefs and projections are expressed in good faith and are believed by us to have a reasonable basis, but there can be no assurance that our expectations, beliefs or projections will result or be achieved or accomplished. We have no obligation to update or revise forward looking statements to reflect the occurrence of future events or circumstances.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

As used in this Quarterly Report: (i) the terms “we”, “us”, “our”, “Strategic”, “Penasco”, “Galveston Bay” and the “Company” mean Strategic American Oil Corporation and its wholly owned subsidiaries, Penasco Petroleum Inc., and Galveston Bay, LLC unless the context otherwise requires; (ii) “SEC” refers to the Securities and Exchange Commission; (iii) “Securities Act” refers to the Securities Act of 1933, as amended; (iv) “Exchange Act” refers to the Securities Exchange Act of 1934, as amended; and (v) all dollar amounts refer to United States dollars unless otherwise indicated.

The following discussion of our plan of operations, results of operations and financial condition as at and for the six months ended January 31, 2012 should be read in conjunction with our unaudited consolidated interim financial statements and related notes for the six months ended January 31, 2012 included in this Quarterly Report, as well as our Annual Report on Form 10-K for the year ended July 31, 2011.

Recent Activities

Acquisition of SPE

On September 26, 2011, we acquired SPE Navigation I, LLC for 95,000,000 shares of Strategic common stock. SPE’s assets at the time of purchase were a 25% working interest in GBE’s historical interest in the Galveston Bay fields, as discussed in the notes to our consolidated financial statements, and one million shares of Hyperdynamics common stock. Hyperdynamics is a public company traded on the NYSE.

Other projects

In February 2012, we began drilling a well, ST 9-12A #4, in the Fisher’s Reef Field located in Trinity Bay near Anahuac, Texas. Through our subsidiary, Galveston Bay Energy LLC, we retained a 25% working interest and operatorship of the well. The remaining 75% working interest was paid by industry and financial partners who have all elected to complete the well based upon our recommendation using down-hole logs, sidewall cores, and other geological data available at the time. Completion operations are now underway.

In September 2011, the operator in our Markham City, Illinois project area commenced drilling of three wells. Two wells were completed in October 2011, one of which is producing oil and the other of which is shut in pending further evaluation. The third well will be used as a water supply well. Water injection operations began in January 2012. As of January 31, 2012, the operator had expended approximately $1,061,000 towards the Earnings Threshold. In accordance with our farmout agreement, we will be required to contribute our 10% working interest share toward operations in the area after the Earnings Threshold, $1,350,000, has been met.

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Results of Operations

Three months ended January 31, 2012 compared to the three months ended January 31, 2011:

Production data:

	Three months ended January 31,
	2012						2011
	Oil (Bbls)		Gas (Mcf)		Total (Mcfe)		Oil (Bbls)		Gas (Mcf)		Total (Mcfe)
Production		14,437		62,885		149,505		1,173		4,542		11,581
Average sales price	$	112.45	$	3.44	$	12.31	$	85.26	$	3.57	$	10.04
Average lease operating expense					$	7.10					$	3.00

Statements of operations:

	Three months ended January 31,
	2012			2011			Increase/ (Decrease)			% Change

Revenues	$	1,839,961		$	116,261		$	1,723,700			1,483	%

Operating expenses
Lease operating expense		1,062,202			39,124			1,023,078			2,615	%
Depreciation, depletion, and amortization		213,833			28,925			184,908			639	%
Accretion		145,912			1,270			144,642			11,389	%
Impairment		-			140,029			(140,029)			(100)	%
Consulting fees – related party		44,856			-			44,856			100	%
Other general and administrative expense		928,787			378,006			550,781			146	%
Total operating expenses		2,395,590			587,354			1,808,236			308	%

Loss from operations		(555,629	)		(471,093	)		(84,536	)		18	%

Interest expense, net		(35,182	)		11,806			(46,988	)		(398)	%
Gain (loss) on derivative warrant liability		126,803			(191,988	)		318,791			(166)	%
Income tax benefit		172,131			-			172,131			100	%

Net Loss	$	(291,877	)	$	(651,275	)	$	359,398			(55)	%

We recorded a net loss of $291,877, or ($0.00) per basic and diluted common share, during the quarter ended January 31, 2012, as compared to a net loss of $651,275, or ($0.01) per basic and diluted common share, during the quarter ended January 31, 2011.

The changes in results were predominantly due to the factors below:

Revenues, lease operating expense, depreciation, depletion, and amortization expense, and accretion expense increased substantially because of the inclusion of the results of our new subsidiaries, GBE and SPE. We purchased GBE on February 15, 2011. We purchased SPE on September 23, 2011. Our consolidated financial statements include the results associated with the working interest in oil and gas properties in Galveston Bay, Texas acquired in these two transactions. Through these working interests, we produced from oil and gas wells in four fields. This represents a substantial increase in our operations.

Consulting fees – related party increased due to the amortization of expense associated with warrants granted as compensation to a company for investor relations and public relations services. This company is a related party, as it is controlled by the father-in-law of our CEO, Jeremy Driver.

Impairment – Impairment expenses for the six months ended January 31, 2012 was $0 as compared to $140,029 for the comparable quarter of 2011. The net book value of our oil and gas properties did not exceed the ceiling and hence there was no impairment recorded on January 31, 2012 in comparison to the prior period where it exceeded the ceiling by $140,029.

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After our purchase of GBE, we secured office space in Houston, Texas and hired additional accounting staff, an operations manager and regulatory manager for GBE. The new location and staff increased our general and administrative expenses by approximately $230,000. Equity based compensation increased approximately $240,000. In addition, we incurred increased professional services fees of $60,000, primarily due to legal costs incurred in the second quarter 2012.

GBE maintains a letter of credit to satisfy a Texas Railroad Commission requirement and has a line of credit with a commercial bank. Because of these arrangements, interest expense increased.

We re-measure our derivative warrants at fair value at every reporting date. The fair value of the derivative warrants, as determined using a lattice model, reduced substantially as of January 31, 2012 as compared with October 31, 2011, resulting in a gain on derivative warrant liability; whereas there was an increase in fair value of the warrants as of January 31, 2011 as compared with October 31, 2010 resulting in a loss on derivative warrant liability in 2011.

We recognized an income tax benefit during the three months ended January 31, 2012 due to an adjustment of the valuation allowance for our deferred tax assets. We determined that current deferred tax assets exist that are sufficient to offset deferred tax liabilities that had been acquired with the purchase of SPE Navigation 1, LLC.

We do not expect the gain on the sale of available for sale securities to occur on a recurring basis. The increases in revenue, lease operating expense, depreciation, depletion, and amortization expense, accretion expense, and interest expense are associated with the operations of GBE and will be an ongoing element in our financial results.

Six months ended January 31, 2012 compared to the six months ended January 31, 2011

Production data:

	Six months ended January 31,
	2012						2011
	Oil (Bbls)		Gas (Mcf)		Total (Mcfe)		Oil (Bbls)		Gas (Mcf)		Total (Mcfe)
Production		27,616		109,898		275,591		2,554		7,413		22,741
Average sales price	$	107.96	$	3.83	$	12.35	$	79.06	$	3.66	$	10.08
Average lease operating expense					$	6.78					$	6.00

Statements of operations:

	Six months ended January 31,
	2012			2011			Increase/ (Decrease)			% Change

Revenues	$	3,402,840		$	229,134		$	3,173,706			1,385	%

Operating expenses
Lease operating expense		1,867,574			140,388			1,727,186			1,230	%
Depreciation, depletion, and amortization		391,843			51,925			339,918			655	%
Accretion		283,794			3,664			280,130			7,645	%
Impairment		-			140,029			(140,029)			(100)	%
Consulting fees – related party		92,613			-			92,613			100	%
Acquisition cost – related party		4,367,750			-			4,367,750			100	%
Other general and administrative expense		2,336,840			1,218,719			1,118,121			92	%
Total operating expenses		9,340,414			1,554,725			7,785,689			501	%

Loss from operations		(5,937,574	)		(1,325,591	)		(4,611,983	)		348	%

Interest expense, net		(102,676	)		(14,779	)		(87,897	)		595	%
Gain (loss) on derivative warrant liability		985,831			(276,549	)		1,262,380			(456)	%
Gain on sale of available for sale securities		433,168			-			433,168			100	%
Income tax benefit		130,183			-			130,183			100	%

Net Loss	$	(4,491,068	)	$	(1,616,919	)	$	(2,874,149	)		178	%

We recorded a net loss of $4,491,068, or ($0.02) per basic and diluted common share, during the six months ended January 31, 2012, as compared to a net loss of $1,616,919 or ($0.03) per basic and diluted common share, during the six months ended January 31, 2011.

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The changes in results were predominantly due to the factors below:

Consulting fees – related party increased due to the amortization of expense associated with warrants granted as compensation to a company for investor relations and public relations services in February 2011. This company is a related party, as it is controlled by the father-in-law of our CEO, Jeremy Driver.

We incurred an expense charge of $4,367,750 due to the excess of the fair value of the purchase price of SPE over the carrying value in the net assets acquired in the SPE acquisition.

After our purchase of GBE, we secured office space in Houston, Texas and hired additional accounting staff, an operations manager and regulatory manager for GBE. Accordingly, general and administrative expenses attributable to compensation and office costs increased by approximately $600,000, which included an increase in equity based compensation of approximately 200,000 due to the amortization of option awards in 2012. Investor relations expense increased $300,000, which is attributable to approximately $600,000 associated with a stock grant during the quarter ended October 31, 2011 offset by an approximately $300,000 decrease in expense due to non-repeated programs from 2011. The other major driver was increased audit and professional fees due to our larger scope of operations and some non-recurring expenditures such as acquisition audits and litigation costs.

GBE maintains a letter of credit to satisfy a Texas Railroad Commission requirement and has a line of credit with a commercial bank. Because of these arrangements, interest expense increased.

We re-measure our derivative warrants at fair value at every reporting date. The fair value of the derivative warrants, as determined using a lattice model, reduced substantially as of January 31, 2012 as compared with July 31, 2011, resulting in a gain on derivative warrant liability; whereas the change in fair value of the warrants in the comparative prior period resulted in a loss.

We acquired equity securities with our acquisition of SPE. We sold securities with a cost basis of $3,510,000 for proceeds of $3,943,168, resulting in a gain on the sale of the securities.

Liquidity and Capital Resources

The following table sets forth our cash and working capital as of January 31, 2012 and July 31, 2011:

	January 31, 2012			July 31, 2011

Cash and cash equivalents	$	3,073,078		$	1,082,099
Working capital (deficit)	$	(263,812	)	$	(3,773,504	)

At January 31, 2012, we had $3,073,078 of cash on hand and a working capital deficit of $263,812 ($1,557,392 is attributable to a warrant derivative liability which would ordinarily be settled in stock). We believe our working capital on January 31, 2012 was sufficient to enable us to pursue our lease operating costs, to pay our general and administrative expenses, and to pursue our plan of operations over the next 12 months.

Various conditions outside of our control may detract from our ability to raise the capital needed to execute our plan of operations, including the price of oil as well as the overall market conditions in the international and local economies. We recognize that the United States economy has suffered through a period of uncertainty during which the capital markets have been depressed from levels established in recent years, and that there is no certainty that these levels will stabilize or reverse. We also recognize that the price of oil decreased from approximately $140 per barrel in 2008 to under $40 per barrel in February of 2009. During our fiscal year ended July 31, 2011, oil price levels increased as to a high of $114 per barrel, but they have decreased to approximately $98 per barrel as of January 2012. If the price of oil drops to levels seen in previous years, we recognize that it will adversely affect our ability to raise additional capital. Any of these factors could have a material impact upon our ability to raise financing and, as a result, upon our short-term or long-term liquidity.

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Net Cash Provided by (Used in) Operating Activities

During the six months ended January 31, 2012, operating activities provided $733,095 in comparison to cash used of $648,492 during the six months ended January 31, 2011. The increase in the cash provided by operating activities is primarily attributable to prepayments received from working interest partners pertaining to their share of the costs of drilling oil and gas wells. Also, prior to our acquisition of GBE, operating activities have primarily used cash as a result of the operating and organizational activities such as consulting and professional fees, direct operating costs, management fees and travel and promotion. With our acquisition of GBE, we expect to derive a much greater percentage of our cash flows from operations from revenues and direct operating costs. Because the GBE properties will increase our contribution margin from our core activities, the acquisition should continue to enhance our cash flows from operations.

Net Cash Provided by Investing Activities

During the six months ended January 31, 2012, investing activities provided cash of $2,907,443 compared to cash provided of $45,044 during the six months ended January 31, 2011. In 2012, the cash provided is mainly attributable to proceeds from the sale of available for sale securities. In 2011, we received proceeds from the sale of oil and gas properties. We expect to use cash in investing in the future due to our planned investment in the fields that we acquired when we acquired GBE.

Net Cash (Used in) Provided by Financing Activities

Financing activities during the six months ended January 31, 2012 used cash of $1,649,559 in comparison to $363,400 provided during the comparable prior period. Financing activities during the current period consisted of payments of existing debt and the line of credit. During the comparable prior period our financing activities consisted primarily of sale of common stock and payments on notes payable.

Critical Accounting Policies

The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and the rules of the Securities and Exchange Commission (“SEC”). The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods.

We regularly evaluate the accounting policies and estimates that we use to prepare our consolidated financial statements. In general, our estimates are based on historical experience, on information from third party professionals, and on various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management.

We believe that our critical accounting policies and estimates include the accounting for oil and gas properties, long-lived assets reclamation costs, the fair value of our warrant derivative liability, and accounting stock-based compensation.

Oil and Natural Gas Properties

Costs associated with unevaluated properties are capitalized as oil and natural gas properties but are excluded from the amortization base during the evaluation period. When we determine whether the property has proved recoverable reserves or not, or if there is an impairment, the costs are transferred into the amortization base and thereby become subject to amortization.

We assess all items classified as unevaluated property on at least an annual basis for inclusion in the amortization base. We assess properties on an individual basis or as a group if properties are individually insignificant. The assessment includes consideration of the following factors, among others: intent to drill; remaining lease term; geological and geophysical evaluations; drilling results and activity; the assignment of proved reserves; and the economic viability of development if proved reserves are assigned. During any period in which these factors indicate that there would be impairment, or if proved reserves are assigned to a property, the cumulative costs incurred to date for such property are transferred to the amortizable base and are then subject to amortization.

Capitalized costs included in the amortization base are depleted using the units of production method based on proved reserves. Depletion is calculated using the capitalized costs included in the amortization base, including estimated asset retirement costs, plus the estimated future expenditures to be incurred in developing proved reserves, net of estimated salvage values.

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The net book value of all capitalized oil and natural gas properties within a cost center, less related deferred income taxes, is subject to a full cost ceiling limitation which is calculated quarterly. Under the ceiling limitation, costs may not exceed an aggregate of the present value of future net revenues attributable to proved oil and natural gas reserves discounted at 10 percent using current prices, plus the lower of cost or market value of unproved properties included in the amortization base, plus the cost of unevaluated properties, less any associated tax effects. Any excess of the net book value, less related deferred tax benefits, over the ceiling is written off as expense. Impairment expense recorded in one period may not be reversed in a subsequent period even though higher oil and gas prices may have increased the ceiling applicable to the subsequent period.

Sales or other dispositions of oil and natural gas properties are accounted for as adjustments to capitalized costs, with no gain or loss recorded unless the ratio of cost to proved reserves would significantly change.

Asset Retirement Obligation

We record the fair value of an asset retirement cost, and corresponding liability as part of the cost of the related long-lived asset and the cost is subsequently allocated to expense using a systematic and rational method. We record an asset retirement obligation to reflect our legal obligations related to future plugging and abandonment of our oil and natural gas wells and gas gathering systems. We estimate the expected cash flow associated with the obligation and discount the amount using a credit-adjusted, risk-free interest rate. At least annually, we reassess the obligation to determine whether a change in the estimated obligation is necessary. We evaluate whether there are indicators that suggest the estimated cash flows underlying the obligation have materially changed. Should those indicators suggest the estimated obligation may have materially changed on an interim basis (quarterly), we will accordingly update our assessment. Additional retirement obligations increase the liability associated with new oil and natural gas wells and gas gathering systems as these obligations are incurred.

Fair Value

The three-level hierarchy is as follows:

Level 1 inputs consist of unadjusted quoted prices for identical instruments in active markets.

Level 2 inputs consist of quoted prices for similar instruments.

Level 3 valuations are derived from inputs which are significant and unobservable and have the lowest priority.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. We have determined that certain warrants outstanding as of the date of these financial statements qualify as derivative financial instruments under the provisions of FASB ASC Topic No. 815-40, “Derivatives and Hedging – Contracts in an Entity’s Own Stock.” These warrant agreements include provisions designed to protect holders from a decline in the stock price (‘down-round’ provision) by reducing the exercise price in the event we issue equity shares at a price lower than the exercise price of the warrants. As a result of this down-round provision, the exercise price of these warrants could be modified based upon a variable that is not an input to the fair value of a ‘fixed-for-fixed’ option as defined under FASB ASC Topic No. 815-40 and consequently, these warrants must be treated as a liability and recorded at fair value at each reporting date.

The fair value of these warrants was determined using a lattice model with any change in fair value during the period recorded in earnings as “Gain (loss) on derivative warrant liability.”

Significant inputs used to calculate the fair value of the warrants include expected volatility, risk-free interest rate and management’s assumptions regarding the likelihood of a future repricing of these warrants pursuant to the down-round provision.

Stock-Based Compensation

ASC 718, “Compensation-Stock Compensation” requires recognition in the financial statements of the cost of employee services received in exchange for an award of equity instruments over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). We measure the cost of employee services received in exchange for an award based on the grant-date fair value of the award.

We account for non-employee share-based awards based upon ASC 505-50, “Equity-Based Payments to Non-Employees.” ASC 505-50 requires the costs of goods and services received in exchange for an award of equity instruments to be recognized using the fair value of the goods and services or the fair value of the equity award, whichever is more reliably measurable. The fair value of the equity award is determined on the measurement date, which is the earlier of the date that a performance commitment is reached or the date that performance is complete. Generally, our awards do not entail performance commitments. When an award vests over time such that performance occurs over multiple reporting periods, we estimate the fair value of the award as of the end of each reporting period and recognize an appropriate portion of the cost based on the fair value on that date. When the award vests, we adjust the cost previously recognized so that the cost ultimately recognized is equivalent to the fair value on the date the performance is complete.

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We recognize the cost associated with share-based awards that have a graded vesting schedule on a straight-line basis over the requisite service period of the entire award.

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes of financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not required because we are a smaller reporting company.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, our Principal Executive Officer and Principal Financial Officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were not effective, due to the deficiencies in our internal control over financial reporting as described in our Annual Report on Form 10-K for our fiscal year ended July 31, 2011, which deficiencies have not yet been remedied.

Internal Control over Financial Reporting

There have not been any changes in our internal controls over financial reporting that occurred during our fiscal quarter ended January 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II Other Information

Item 1. Legal Proceedings

As of January 31, 2012, we were a party to the following legal proceedings:

1. Cause No. 2011-37552; Strategic American Oil Corporation v. ERG Resources, LLC, et al.; In the 55th District Court, Harris County, Texas. The Company is a plaintiff in this suit. In this case, Company brought claims for injunctive relief, breach of contract and fraudulent inducement against the defendant regarding the purchase of Galveston Bay Energy, LLC from ERG. The Company intends to prosecute its claims and defenses vigorously. As of the date of filing of this report, the Company is no longer seeking injunctive relief.

2. Cause No. 2011-54428; ERG Resources, LLC v. Galveston Bay Energy, LLC, in the 125th Judicial District Court, Harris County, Texas. This case deals with the operating agreements for the processing of product by the entities owned by ERG. It is an action seeking payments of charges and expenses by ERG that are refuted by GBE. The Company intends to prosecute its claims and defenses vigorously.

Item 1A. Risk Factors

For information regarding our risk factors see the risk factors disclosed in Item 1A of our Annual Report on Form 10-K filed on November 15, 2011. There have been no material changes from the risk factors previously disclosed in such Annual Report.

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

On December 6, 2011, we issued 325,917 restricted common shares of our common stock to our Chief Financial Officer at a deemed issuance price of $0.085 per share in payment of accrued payroll obligations.

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Item 3. Defaults Upon Senior Securities

None.

Item 4. (Removed and Reserved)

None.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit No.		Description of Exhibit
31.1		Certification of Chief Executive Officer of Strategic American Oil Corporation required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer of Strategic American Oil Corporation required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer and Chief Financial Officer of Strategic American Oil Corporation pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and Section 1350 of 18 U.S.C. 63.

101.INS		XBRL INSTANCE DOCUMENT

101.SCH		XBRL TAXONOMY EXTENSION SCHEMA

101.CAL		XBRL TAXONOMY EXTENSION CALCULATION LINKBASE

101.DEF		XBRL TAXONOMY EXTENSION DEFINITION LINKBASE

101.LAB		XBRL TAXONOMY EXTENSION LABEL LINKBASE

101.PRE		XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE

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Signatures

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

STRATEGIC AMERICAN OIL CORPORATION

/s/ Jeremy Glenn Driver
Jeremy Glenn Driver
President, Chief Executive Officer, Principal Executive Officer
and a director
Date: March 21, 2012

/s/ Sarah Berel-Harrop
Sarah Berel-Harrop
Secretary, Treasurer, Chief Financial Officer and Principal
Accounting Officer
Date: March 21, 2012

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