Losses increased five-fold at Faroe Petroleum in 2006, when the two wells drilled by the company which was formed to focus on the wilds off the eponymous islands failed to find commercial deposits.

However, directors said that after spreading its bets to include smaller but less risky prospects closer to home, Faroe was well placed for the future.

Aberdeen-based Faroe reported a pre-tax loss of £2.4m for the year ended December 31, which compared with a restated loss of £464,000 in the preceding period.

The loss reflected increased activity by the company, which expanded into Norway by recruiting the local team of the former Paladin Resources.

The picture was clouded by the fact the 2006 loss was stated after charging £800,000 in unrealised losses on foreign exchange movements.

However, Faroe did not enjoy much success with the drill bit.

A well on the Brugdan prospect in Faroese waters found traces of hydrocarbons but not in commercial quantities.

While management said the exercise yielded important information, four years after drilling its first well off the Faroes the company is still waiting to make a commercial find off the country.

Another wildcat exploration well on the Halibut prospect in the outer Moray Firth also failed to find hydrocarbons in commercial quantities.

However, chairman Joe Darby said Faroe made significant progress in 2006, during which the company increased the number of licences it had stakes in by 120%, to 33.

Directors believe the company's 13 licences in the Atlantic margin off the Faroes and west of Shetland gives it an important presence in an under-explored area which is attracting increased interest from majors.

Faroe has been awarded six licences in Norway, where much less exploration work has been completed than in the UK North Sea, and oil and gas firms enjoy generous tax breaks.

Faroe has also acquired interests in southern North Sea gas fields including Breagh, which might be brought into production relatively quickly, subject to completing appraisal and development work.

It has formed a joint venture with Liberty Mutual the US insurer to buy undeveloped North Sea discoveries.

After raising £23.5 net of expenses in a placing last year Faroe had £33m at the year end. This would be enough to fund an active drilling programme, including two wells in the southern North Sea planned for 2007. Faroe also hopes to drill on the Freya field west of Shetland in 2007.

Richard Slape, an analyst at Natexis bank, said that Faroe offered an exciting mix of high-risk, high-reward exploration plus several smaller, but safer appraisal and development assets.

He said there seemed to be a good chance that Faroe might be able to book significant reserves at Freya and Breagh in 2007, which could form the basis of a substantial exploration and production firm.

Shares in Faroe Petroleum closed down 1.5p at 112.5p.