**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549**

 

**Form 10-KSB**

 
| **ý****  ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d)**                                                                                                                         |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                            |
|                                                                                                                                                                                                  |   |   |
| **For the fiscal year ended December 31, 2005**                                                                                                                                                  |
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| **Or**                                                                                                                                                                                                |
|                                                                                                                                                                                                  |   |   |
| **o****  TRANSISTION REPORT PURSUANT TO  SECTION 13 OR 15(d)**                                                                                                                         |
| **OF THE SECURITIES EXHANGE ACT OF 1934**                                                                                                                                                             |
| ** **                                                                                                                                                                                            | ** ** | ** ** |
| **For the  transition period from                  to            ** |
| ** **                                                                                                                                                                                            |
| **Commission  File Number: 000-29098**                                                                                                                                                                |

 

**BPZ Energy, Inc.**

(Exact name of registrant as specified in itscharter)

 
| **Colorado**                                    | ** ** | **33-0502730**                           |
|-------------------------------------------------|------------|------------------------------------------|
| (State or other  jurisdiction of incorporation) |       | (I.R.S. Employer  Identification Number) |

** **

**580 WestlakePark Blvd., Suite 525****Houston, Texas 77079**(Address of principal executive office)

 

Registrant’stelephone number, including area code: **(281)556-6200**

 

Securitiesregistered pursuant to Section 12(b) of the Exchange Act: **None**

 

Securitiesregistered pursuant to Section 12(g) of the Exchange Act: **Common Stock, Without Par Value**

 

Checkwhether the issuer is not required to file reports pursuant to Section 13 or15(d) of the Exchange Act. o

 

**Note** –Checking the box above will not relieve any registrant required to file reportspursuant to Section 13 or 15(d) of the Exchange Act from their obligationsunder those Sections.

 

Indicateby check mark whether the Registrant (1) filed all reports required to be filedby Section 13 or 15(d) of the Exchange Act during the past 12 months(or for such shorter period that the Registrant was required to file suchreports), and (2) has been subject to such filing requirements for thepast 90 days.            Yes ýNo o

 

Indicateby check mark if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B contained herein, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of thisForm 10-KSB or any amendment to thisForm 10-KSB.           o

 

Indicate by check mark whether the Registrant is a Shell Company (asdefined in Rule 12b-2 of the Exchange Act     Yes oNo ý)

 

Registrantdid not earn revenues for the fiscal year ended December 31, 2005.

 

Thenumber of shares of Common Stock held by non-affiliates as of March 20,2006 was 26,374,534 shares, all of one class of common stock, no par value,having an aggregate market value of approximately $89,673,174 based upon theclosing price of Registrant’s common stock on such date of $3.40 per share****as quoted****on the Over-the-Counter Pink Sheets (“OTC PK”).

 

Asof March 20, 2006, BPZ Energy, Inc. had 42,322,515 shares of commonstock outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portionsof the registrant’s Proxy Statement for the 2006 Annual Meeting of Shareholdersto be filed no later than April 30, 2006 are incorporated by reference in Part III****of this Form 10-KSB.

 

TransitionalSmall Business Disclosure Format (check one): Yes o   No ý

 

 

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**TABLEOF CONTENTS**

 
| **PART I**   |                                                                                            |   |
|-------------------|-------------------------------------------------------------------------------------------------|--------|
|              |                                                                                            |   |
| Item 1.           | Description of Business                                                                         |   |
| Item 2.           | Description of  Property                                                                        |   |
| Item 3.           | Legal  Proceedings                                                                              |   |
| Item 4.           | Submission of  Matters to a Vote of Security Holders                                            |   |
|              |                                                                                            |   |
| **PART II**  |                                                                                            |   |
| Item 5.           | Market for Common Equity and Related Stockholder Matters                                        |   |
| Item 6.           | Management’s Discussion and Analysis and Plan of Operation                                 |   |
| Item 7.           | Financial  Statements                                                                           |   |
| Item 8.           | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosures          |   |
| Item 8A.          | Controls and Procedures                                                                         |   |
| Item 8B.          | Other  Information                                                                              |   |
|              |                                                                                            |   |
| **PART III** |                                                                                            |   |
| Item 9.           | Directors and Executive Officers of the  Registrant                                             |   |
| Item 10.          | Executive Compensation                                                                          |   |
| Item 11.          | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters |   |
| Item 12.          | Certain Relationships and Related  Transactions                                                 |   |
| Item 13.          | Exhibits                                                                                        |   |
| Item 14.          | Principal Accountant Fees and Services                                                          |   |
|              |                                                                                            |   |
| **SIGNATURES**    |                                                                                            |   |
|              |                                                                                            |   |
| Certifications    |                                                                                            |   |

 

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# **PART I**

#  

*BPZ Energy, Inc.(“BPZ” or the “Company”) cautions that this document contains forward-lookingstatements within the meaning of Section 27A of the Securities Act and Section 21Eof the Exchange Act. All statements, other than statements of historical facts,included in or incorporated by reference into this Form 10-KSB whichaddress activities, events or developments which the Company expects, believesor anticipates will or may occur in the future are forward-looking statements.The words “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,”“predicts” and similar expressions are also intended to identify forward-lookingstatements. These statements are based on certain assumptions and analyses madeby the management of BPZ in light of its experience and its perception ofhistorical trends, current conditions and expected future developments as wellas other factors it believes are appropriate in the circumstances. BPZ cautionsthe reader that these forward-looking statements are subject to risks anduncertainties, many of which are beyond BPZ’s control that could cause actualevents or results to differ materially from those expressed or implied by thestatements. See “Risk Factors” included in Item 1 - Description of the Businessof this Form 10-KSB.*

 

**Item 1. Description of Business**

 

**General**

 

BPZ Energy, Inc., a Colorado corporation wasincorporated in 1993. It was formerly named Navidec, Inc. Based in Houston,Texas, we are a development stage companywith properties in northwest Peru and southwest Ecuador. We arefocused on the development and production of oil and natural gas and we intendto utilize part of our future natural gas production for the complementarydevelopment of gas-fired power generation.

 

On September 10, 2004, BPZ Energy, Inc., aTexas corporation (“BPZ-Texas”), consummated a reverse merger with Navidec,Inc. (“Navidec”) whereby BPZ-Texas became a wholly owned subsidiary of Navidec(the “Merger”). However, in the Merger, the stockholder group of BPZ-Texasobtained majority ownership and management control of the combined Company.Accordingly, for accounting purposes, the Merger was treated as a reversemerger of Navidec by BPZ-Texas. All financial statements presented hereinrepresent the historical financial statements of the accounting acquirer,BPZ-Texas. The details of the Merger are discussed in Note 2 to theConsolidated Financial Statements. On February 4, 2005, the legal parentcompany, Navidec, Inc., changed its name to BPZ Energy, Inc. Although theCompany’s name has been changed, the pre-merger company may be referred to asNavidec in this filing to avoid confusion.

 

We maintain an office anda registered branch in Peru. Currently, we have exclusive rights andlicense agreements for oil and gas exploration and production covering a totalof approximately 2.7 million acres in northwest Peru. Our licensecontracts cover 100% ownership of both Block Z-1, which was signed in November2001 and Block XIX, which was signed in December2003. Ourlicense contractsprovide for an initial exploration period of seven to ten years and requirethat we conduct specified activities on the properties during this period. Thetotal contract term can extend up to 30 years for oil developmentand production and 40 years for gas development and production. In December2003, we entered into a Technical Evaluation Agreement for AreaVI. Thisagreement gave us the right to conduct a technicalevaluationof the area over a 24-month period and the exclusive right toenter into a license contract if the evaluationindicated the potential for successful operations. In December2005, we initiated negotiations to obtain a license contract for Area VI.

 

We also own a 10%non-operated working interest in a producing oil and gas propertylocated in the southwest region of Ecuador (the “Santa Elena Property”). Thelicense agreement covering the property extends through May 2016.

 

We are in the developmentstage and to date our activities in Peru have been limited to analysis andevaluation of technical data on the properties and preparation of thedevelopment plans for the properties. We have not drilled any wells or recognizedany revenues from operations and we do not anticipate generating significantrevenues from our properties prior to 2007.

 

**NavidecMerger Transaction**

 

On July 8, 2004, BPZ-Texas and Navidec entered into a MergerAgreement (the “Merger Agreement”) providing for the acquisition of BPZ-Texasby Navidec in a transaction intended to qualify as a tax free share exchange. TheMerger was consummated on September 10, 2004.

 

As a result of the Merger, the shareholdersof BPZ-Texas received the majority of the voting interests and control of theBoard of Directors and management of the combined entity. Accordingly, theMerger was treated as a reverse acquisition of Navidec by BPZ-Texas and hasbeen accounted for as a business combination as more fully described in Note 2of the Notes to Consolidated Financial Statements. The historical financialstatements of the Company for periods prior to the Merger are the historicalfinancial statements of BPZ-Texas.

 

The Merger Agreement provided for the immediate issuance by Navidec of9,000,000 shares of its common stock to the shareholders of BPZ-Texas and thefuture issuance of an additional 18,000,000 shares on an earn-out basis if theCompany

 

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achieves certain reserve and production goals. The first 9,000,000earn-out shares were contingent on achieving certain reserve targets, whichtargets were achieved in December 2004. The remaining 9,000,000 earn-outshares are contingent on the Company achieving production of 2,000 barrels ofoil per day or its equivalent (approximately 12 million cubic feet of gas perday) prior to December 28, 2007. Upon completion of the Merger, theofficers and directors of Navidec resigned, except for the former CEO ofNavidec, John R. McKowen, who remained a director. Mr. McKowen, togetherwith the management and the four directors of BPZ-Texas, became the executiveofficers and directors of the surviving entity.

 

As part of the Merger transaction, Navidec agreed to provide through aprivate placement not less than $3 million or more than $6 million inadditional equity capital for the operations and working capital needs ofBPZ-Texas. This private placement was closed as of September 30, 2004, with$6.0 million of total gross proceeds. Net proceeds of approximately$5.5 million became available for use in connection with the businessoperations of BPZ-Texas.

 

The Merger Agreement also provided that all of the pre-merger business operations, assets and liabilities of Navidec would be transferred to a wholly-owned subsidiary, Navidec Financial Services, Inc. (“NFS”), followed by the spin-off of NFS to the pre-merger shareholders of record as of September 9, 2004, the date prior to consummation of the Merger. Accordingly, the pre-merger shareholders of BPZ-Texas will not be entitled to receive shares of NFS. All legal requirements for the spin-off of NFS have been completed except for registration of the spin-off with the Securities and Exchange Commission and the final distribution of the common shares of NFS to the pre-merger shareholders of the Company. Pending such final distribution of shares, the Company remains the nominal owner of the majority of the common shares of NFS, which shares are being held by the Company for the benefit of the spin-off shareholders. The Company has no control over the registration process of NFS and cannot predict when the management of NFS will be able to complete the final distribution of NFS common shares. NFS is organized into three divisions: business development, mortgage services and technology. Subsequent to the Merger, NFS has operated independently of the Company. Each company maintains separate offices, bank accounts and management and the lines of business and operations of the two companies are completely independent. The Company does not control NFS and accounts for its nominal ownership in NFS under the equity method of accounting.

 

In February 2006, we filed a petition in the District Court of Arapahoe County, Colorado for the judicial dissolution of NFS and the appointment of a receiver for NFS. See “Item 3. Legal Proceedings” for further discussion. If this action is successful, it is possible the NFS shares will not be distributed as such, but we believe the then remaining financial value of NFS would be distributed to the pre-merger shareholders of Navidec. This action is being contested by NFS and we cannot predict the outcome or timing of this matter.

 

**AvailableInformation**

 

TheCompany files annual, quarterly and current reports, proxy statements and otherdocuments with the Securities and Exchange Commission (“SEC”) under theSecurities Act of 1934. The public may read and copy any materials that we filewith the SEC at the SEC’s Public Reference Room at Headquarters Office,100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtaininformation on the operation of the Public Reference Room by calling theSEC at 1-800-SEC-0330. Also, the SEC maintains an Internet website thatcontains reports, proxy and information statements, and other informationregarding issuers, including us, that file electronically with the SEC. Thepublic can obtain any documents that we file electronically with the SEC athttp://www.sec.gov. In addition, the Company maintains a website(http://www.bpzenergy.com), on which we make available, free of charge, all ofthe Company’s above mentioned filings with the SEC, including Forms 3, 4 and 5filed with respect to our equity securities under Section 16(a) ofthe Securities Act of 1934. These filings will be available as soon asreasonably practicable after we electronically file such material with, orfurnish it to, the SEC.

 

**Competition**

 

There is intense competition in the oil and gas industry with respectto the acquisition of producing properties, undeveloped acreage, and rights toexplore for these properties. Many major and independent oil and gas companiesactively pursue and bid for the mineral rights of desirable properties, andmany companies have been actively engaged in acquiring oil and gas propertiesin Peru and Ecuador.

 

We believe that our early efforts and knowledge of our targeted areashave given us a competitive advantage in Peru, and to a lesser extent, inEcuador. Although there are unleased tracts within our target area, we believethat these properties may be less attractive to other companies because it willbe difficult for them to obtain a significant amount of contiguous mineralacreage. This results in part from our significant holdings in the vicinity ofthese unleased tracts. However, increased demand for license rights insurrounding areas may impact our ability to expand and grow in the future,particularly because many of our competitors have substantially greaterfinancial and other resources, better name recognition and longer operatinghistories. As a result, we may not be able to acquire additional oil and gasproperties in desirable locations.

 

There is also intense competition in the oil and gas industry foraccess to contract drillers, geologists, and others needed to drill and completewells. Current demand for drilling and contract services in our target areaappears to be reasonably stable, and we believe our early entry will allow usto build the relationships necessary for our success. We do not anticipate thatcompetition in this area will dramatically affect our plan of operation. However,increased future demand for drillers and contractors may limit our ability toexpand in a timely manner and may negatively impact our ability to grow.

 

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**Regulation**

 

***General***

 

Various aspects of our oil and natural gas operations are currently orwill be subject to various foreign laws and governmental regulations. Theseregulations may be changed from time to time in response to economic or politicalconditions. Although we believe that our operations are and will be insubstantial compliance with existing legislation and requirements ofgovernmental bodies, our ability to conduct continued operations is subject tosatisfying applicable regulatory and permitting controls. Our principals havemany collective decades of experience in dealing directly with the Peruviangovernment on energy projects and in some cases have been directly involved inthe drafting and promulgation of petroleum legislation. Therefore, we believewe are in a unique position to understand and comply with local rules andregulations. However, our current permits and authorizations and our ability toobtain future permits and authorizations may, over time, be susceptible to increasedscrutiny and greater complexity which could result in increased costs or delaysin receiving appropriate authorizations.

 

***Peru***

 

***Peruvian hydrocarbon legislation.***Peru’s hydrocarbonlegislation, which includes the Organic Hydrocarbon Law No. 26221 and theregulations there under (the “Organic Hydrocarbon Law”), governs our operationsin Peru. This legislation covers the entire range of petroleum operations,defines the roles of Peruvian government agencies which regulate and interactwith the oil andgasindustry, requires that investments in the petroleum sector be undertakensolely by private investors (either national or foreign), and provides for thepromotion of the development of hydrocarbon activities based on freecompetition and free access to all economic activities. This law provides thatpipeline transportation and natural gas distribution must be handled viacontracts. All other petroleum activities are to be freely operated and aresubject only to local and international safety and environment standards.

 

Under this legal system, Peru is the owner of the hydrocarbons locatedbelow the surface in its national territory. However, Peru has given theownership right to extracted hydrocarbons to Perupetro, a state company that isresponsible for promoting and overseeing the investment of hydrocarbonexploration and exploitation activities in Peru. Perupetro is empowered toenter into contracts for either the exploration and exploitation or theexploitation of petroleum and gas on behalf of Peru, which are describedfurther below. The Peruvian government also plays an active role in petroleumoperations through the involvement of the Ministry of Energy and Mines, thespecialized government department in charge of devising energy, mining and environmentalprotection policies, enacting the rules applicable to all these sectors andsupervising compliance with such policies and rules. Within the office of thePrime Minister resides the Supervising Office for Investments in Energy (“OSINERG”),which is the body charged with economic and technical supervision. We aresubject to the laws and regulations of all of these entities and agencies.

 

Perupetro generally enters into license contracts for hydrocarbonexploration and exploitation. Peru’s laws also allow for other contract models,such as service contracts, but the investor will be subject to contract termsthat are compatible with Peru’s interests. A company must be qualified byPerupetro to enter into hydrocarbon exploration and exploitation contracts inPeru. In order to qualify, the company must meet the standards under theRegulations Governing the Qualifications of Oil Companies. These qualificationsgenerally require the company to have the technical, legal, economic andfinancial capacity to comply with all obligations it will assume under thecontract based on the characteristics of the area requested, the possibleinvestments required and the environmental protection rules governing theperformance of its operations. When a contractor is a foreign investor, it isexpected to incorporate a subsidiary company or registered branch in accordancewith Peru’s corporate laws and appoint representatives who will interact withPerupetro.

 

Our Peruvian branch, BPZ Energy, Inc., Sucursal Peru, has been qualifiedby Perupetro with respect to our current contracts. However, Perupetro reviewsthe qualification for each specific contract to be signed by a company.Additionally, the qualification for foreign companies is granted in favor ofthe home office or corporation, which is jointly and severally liable at alltimes for the technical, legal, economic and financial capacity of the Peruvianbranch.

 

When operating under a license contract, the licensee is the owner ofthe hydrocarbons extracted from the contract area during the performance ofoperations, and pays royalties which are collected by Perupetro. The licenseecan dispose of the petroleum in any manner whatsoever, subject to a limitationin the case of natural emergencies where the law stipulates the manner ofdisposal.

 

Licensees are obligated to submit quarterly reports to the PetroleumBureau (Direccion General de Hidrocarburos). Licensees must also submit amonthly economic report to the Central Bank of Peru. These reports aregenerally combined and delivered together with other operating reports requiredto be submitted to Perupetro.

 

Previously, all license contracts were granted by the Ministry ofEnergy and Mines. The change to Perupetro as the license contract grantorsubjects all license contracts to a new legal framework. Although there hasbeen over twelve years of precedent for these new licensing procedures, thereis still some uncertainty as to exactly how the licensing procedure willfunction in the future.

 

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Under exploration service contracts, the ownership of all of theextracted hydrocarbons is vested in Perupetro and the company will receivecompensation agreed to by the parties. However, Perupetro is granted the powerto remunerate the investor either in cash or in kind, depending on the level ofinvestment and the volume of production. We have no service contracts , nor dowe foresee operating under this form of contract.

 

The duration of the contracts is based on the nature of the hydrocarbonsdiscovered. The license contract duration for crude oil is thirty years, whilethe license contract duration for natural gas and condensates is forty years.The periods commence on an agreed date and are determined based on location ofthe contract area, season of the year in which exploration commences, and othersimilar factors. License contracts typically include an exploration phase andan exploitation phase, unless the contract is solely an exploitation contract.Within the license contract term, seven years is allotted to exploration, withthe possibility of three extensions of one year each. There is also a potentialdeferment period for a maximum of ten years if certain factors recognized bylaw delay the economic viability of a discovery, such as lack of transportationfacilities or lack of a market. The exploration phase is generally divided intoseveral periods, with a maximum of seven periods,  and each period includes a minimum workprogram. The fulfillment of work programs must be supported by an irrevocablebank guaranty, usually in the amount of thirty to forty percent of theestimated value of the minimum work program.

 

Perupetro also grants technical evaluation agreements. These agreementsgive the contractor the right to conduct technical evaluations of the areasunder such agreements and to enter into license contracts if the evaluationsindicate the potential for profitable operations. The technical evaluationagreement is generally for a period of twenty-four months, depending upon thevolume and nature of the work to be carried out.

 

We currently have two license contracts and one technical evaluation agreement. As of December 31, 2005, we believe we were incompliance with all of the material requirements of each of such contracts. Wehave executed certain letters of guaranty to guarantee our performance underthe license contracts and technical evaluation agreements, including a $1.3million bond posted in January 2005 and a $350,000 bond posted in August 2005to secure our current obligations under the license contracts for Block Z-1 andBlock XIX, respectively. These bonds were secured by the deposit of restrictedcash with the financial institution which issued the bond. Should we fail tofulfill our obligations under the license contracts, without technicaljustification or other good cause, Perupetro could seek recourse to the bond orterminate the license.

 

***Peruvian fiscal regime.***Peru’s fiscal regimedetermines the levels of the government’s entitlement from petroleum activities.This regime is subject to change, which could negatively impact our business.

 

Contractors under license contracts are subject to royalty payments,which are usually a fixed percentage of the actual production sold. The taxingregulations stipulate a minimum royalty payment of fifteen percent. Acontractor is sometimes granted the right to pay less based on thecircumstances. Under a Service Contract, Perupetro receives all of thepetroleum produced on behalf of Peru and the contractor is remunerated for thevolume produced at a price stipulated under the contract.

 

The Organic Hydrocarbon Law and the Regulations Governing the TaxStability Guaranty and Other Tax Rules of the Organic Hydrocarbon Law providethat the tax regime in force on the date of signing a contract will remainunchanged during the term of the contract. Therefore, any change to the taxregime, which results in either an increase or decrease in the tax burden, willnot affect the contractor.

 

During the exploration phase, contractors are exempt from import dutiesand other forms of taxation applicable to goods intended for explorationactivities. Exemptions are withdrawn at the production phase. In certaininstances, the contractor is entitled to import goods tax-free for a two-year period.

 

Income tax is levied on the income of the contractor based upon thecurrent legal corporate tax rate in effect at the date the contract was signed.Contractors engaged in the exploration and production of crude oil, natural gasand condensates must determine their taxable income separately for each ofthese activities. Where a contractor carries out these activities in more thanone area under different individual contracts, it may consolidate all costs andexpenses incurred in overall operations for purposes of determining thecorporate income tax.

 

***Peruvian labor and safety legislation.***Our operations in Peru willalso be subject to the Unified Labor Law, which governs the labor force in thepetroleum sector. In addition, the Organic Hydrocarbon Law and related SafetyRegulations for the Petroleum Industry also regulate the safety and health ofworkers involved in the development of hydrocarbon activities. All entitiesengaged in the performance of activities related to the petroleum industry mustprovide the General Hydrocarbons Bureau on a semi-annual basis with the list oftheir personnel, indicating their nationality, specialty and position. Theseentities must also permanently train their workers on the application of safetymeasures in the operations, and control of disasters and emergencies. Eachentity must keep detailed records of all accidents that occur in its operationsand report all accidents to the General Hydrocarbons Bureau. The regulationsalso contain provisions on accident prevention and personnel health and safety,which in turn include rules on living conditions, sanitary facilities, waterquality at workplaces, medical assistance and first-aid services. Provisionsspecifically related to the exploration phase, which is our current phase ofoperations, are also contained in the regulations and include safety measuresin camps, medical assistance, food conditions, and handling of explosives.Additional safety regulations may also apply as we expand and develop ouroperations.

 

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***Peruvian electric power legislation.***Our business plan envisionsthe generation of electricity and the sale of such electric power in Peru. Thebasic laws in Peru governing electric power, which will apply to our futureoperations, are the Law of Electric Power Concessions and the Regulations forthe Environmental Protection of Electric Power Activities, the correspondingregulations for each, as well as additional related laws and regulationsincluding all legislation regarding Electric Power Tariffs and all regulationsand technical norms created by the National Commission of Electric PowerTariffs.

 

***Peruvian environmental regulation.***Our operations are subjectto numerous and frequently changing laws and regulations governing thedischarge of materials into the environment or otherwise relating toenvironmental protection. Peru has enacted specific environmental regulationsapplicable to the petroleum industry. The Code on the Environment and theNatural Resources establishes a framework within which all specific laws andregulations applicable to each sector of the economy are to be developed. Theselaws and regulations are designed to ensure the continual balance ofenvironmental and petroleum interests. The regulations stipulate certainenvironmental standards expected from contractors. They also specifyappropriate sanctions to be enforced by the Ministry of Mines and Energy if acontractor fails to maintain such standards. The Ministry of Mines and Energy ischarged with the responsibility of issuing the applicable standards. OSINERG isresponsible for ensuring compliance with applicable environmental rulescovering hydrocarbon activities.

 

The Organic Hydrocarbon Law also addresses the environmental regulatoryregime in Peru. The law originally prohibited any mining or extractiveoperations within certain areas designated for protection. It was, however,subsequently modified to enable investors to prospect for hydrocarbons withinprotected areas, provided there is compliance with several obligations. We mustcomply with these obligations as we conduct our business on an ongoing basis.The Environmental Regulations for Hydrocarbon Activities provide that companiesparticipating in the implementation of projects, performance of work andoperation of facilities related to hydrocarbon activities are responsible forthe emission, discharge and disposal of wastes into the environment. Companiesmust annually file a report corresponding to the previous year describing thecompany’s compliance with the environmental legislation in force.

 

Companies involved in hydrocarbon activities must also prepare and filean Environmental Impact Study (“EIS”) with the General Hydrocarbons Bureau,which is part of the Ministry of Energy and Mines, in order for the relevantactivities to comply with the maximum permissible emission limits set forth bythe Ministry of Energy and Mines. An EIS must be prepared for each project tobe carried out. All of these proposals must be approved by the GeneralEnvironmental Bureau, which is also part of the Ministry of Energy and Mines.

 

In addition, any party responsible for hydrocarbon activities must filean “Oil Spill and Emergency Contingency Plan” with the General HydrocarbonsBureau. The plan must be updated at least once a year and must containinformation regarding the measures to be taken in the event of spills,explosions, fires, accidents, evacuation, etc. It must also contain informationon the procedures, personnel and equipment required to be used and proceduresto be followed to establish uninterrupted communication between the personnel,the government representatives, the General Hydrocarbons Bureau and other Stateentities.

 

Any failure to comply with environmental protection rules, the importof contaminated products, or failure to keep a monitoring register or sendreports to the General Hydrocarbons Bureau in a timely fashion, could subjectthe company to fines. In addition, the General Hydrocarbons Bureau may considerimposing a prohibition or restriction of the relevant activity, an obligationto compensate the aggrieved parties and/or an obligation to immediately restorethe area. The company responsible for any default can also be subject to asuspension of operations for a term of one, two or three months, orindefinitely. Furthermore, any contract signed with the Peruvian government,the implementation of which jeopardizes or endangers the protection orconservation of protected natural areas, can be terminated.

 

We are subject to all Peruvian environmental regulations now inexistence and those existing in the future. The enactment and enforcement ofenvironmental laws and regulations in Peru is relatively new. We are thereforeuncertain how Peruvian authorities will enforce and supervise environmentalcompliance and standards. Further, we cannot predict any future regulation orthe cost associated with future compliance.

 

Although we believe that our operations are in substantial compliancewith existing environmental requirements, our ability to conduct continuedoperations is subject to satisfying applicable regulations. Our current permitsand authorizations and ability to obtain future permits and authorizations maybe susceptible, on a going forward basis, to increased scrutiny, greatercomplexity resulting in increased costs, or delays in receiving appropriateauthorizations. In particular, we may experience in the future delays inobtaining permits and authorizations in Peru necessary for our operations. Weare required to obtain an environmental permit or approval from the governmentin Peru prior to conducting any seismic operations, drilling a well orconstructing a pipeline in Peruvian territory, including the waters in offshorePeru where we intend to conduct oil and gas operations.

 

***Compliance with Existing Regulations in Peru***

 

Although we believe that our operations are and will be in substantialcompliance with existing legislation and requirements of Peruvian governmentalbodies, our ability to conduct continued operations is subject to satisfyingapplicable regulatory and permitting controls. As noted above, our principalshave many collective decades of experience in dealing directly

 

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with the Peruvian government on energy projects and in some past caseshave been directly involved in the drafting and promulgation of petroleumlegislation. Therefore, we believe we are in a good position to understand andcomply with local rules and regulations.

 

***Compliance with Existing Regulations in Ecuador***

 

SMC Ecuador, Inc. has owned its 10% non-operating interest in the Santa Elenaoil fields for the past nine years. As a non-operator, we are not directlysubject to the laws and regulations of Ecuador covering the oil and gasindustry and the environment. However, if we begin operating activities inEcuador, we will be directly subject to such laws and regulations.

 

**EnvironmentalCompliance and Risks**

 

As an owner or lessee and operator of oil and gas properties throughoutSouth America, we are subject to various national, state and local laws andregulations relating to discharge of materials into, and protection of, theenvironment. These laws and regulations may, among other things, imposeliability on the contractor under an oil and gas license agreement for the costof pollution clean-up resulting from operations, subject the contractor toliability for pollution damages, and require suspension or cessation ofoperations in affected areas.

 

We do not presently maintain environmental insurance coverage, because,in management’s judgment, such coverage is not cost-effective at this time in view of ourlimited activities. However, we may acquire such insurance coverage in thefuture based on our assessment of the risks of our operations and the costs ofsuch coverage. No such coverage can insure us fully against all environmentalrisks. We are not aware of any environmental claims existing which would have amaterial impact upon our financial position or results of operations.

 

We have made and will continue our efforts to comply with theserequirements, which we believe are necessary to successful long-term operationsin the oil and gas industry. We have established guidelines for continuingcompliance with environmental laws and regulations. In order to carry out ourplan of operation, we are required to conduct environmental impact studies andobtain environmental approvals for operations. We have engaged outsideconsultants to perform these studies and assist us in obtaining necessaryapprovals. Our estimated cost for these studies and assistance is approximately$370,000, of which approximately $257,000 had been incurred as of December 31, 2005.

 

We do not believe that compliance with federal, state or localprovisions regulating the discharge of materials into the environment, orotherwise relating to the protection of the environment, will have a materialadverse effect upon the capital expenditures, earnings or competitive positionof the Company or its subsidiaries. However, there is no assurance that changesin or additions to laws or regulations regarding the protection of theenvironment will not have such an impact.

 

**OperationalHazards and Insurance**

 

Our operations will be subject to the usual hazards incident to the drillingand production of oil and gas, such as blowouts, cratering, explosions,uncontrollable flows of oil, gas or well fluids, fires, pollution, releases oftoxic gas and other environmental hazards and risks. These hazards can causepersonal injury and loss of life, severe damage to and destruction of propertyand equipment, pollution or environmental damage and suspension of operations.

 

We will evaluate whether to obtain general liability insurance and inwhat amounts based on whether we believe the terms and costs are reasonable forour operations. Such insurance will not cover every potential risk associatedwith the drilling, production and processing of oil and gas. In particular,coverage is not obtainable for all types of environmental hazards. The occurrenceof a significant adverse event, the risks of which are not fully covered byinsurance, could have a material adverse effect on our financial condition andresults of operations. Moreover, no assurance can be given that we will be ableto obtain or maintain adequate insurance at rates we consider reasonable.

 

**Researchand Development**

 

BPZ seeks to use advanced technologies in the evaluation of its oil andgas properties and new opportunities. BPZ generally does not develop suchtechnologies internally, but its technical team works with outside vendors totest and utilize these technologies to the fullest practical extent,particularly in the application of geophysical and exploration software. Incertain cases, the collaboration of BPZ has aided the development of thesetechnologies. BPZ does not believe it has incurred any quantifiable incrementalcosts in research and development activities.

 

**Employees**

 

As of December 31, 2005, we employed 16 full-time employees (ofwhich 3 are executive officers) in our Houston, Texas office, and 7 full-time employees (of which 1 is an executiveofficer)in theLima,Peru office. BPZ believes that its relationship with its employees issatisfactory. None of our employees are representedby a union.

 

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**RISKFACTORS**

 

**RisksRelating to the Oil and Natural Gas Industry, Power Industry and Our Business**

 

***Wehave a limited operating history and have only engaged in start-up activities.***AlthoughBPZ-Texas was formed in 2001, we are in the development stage becausewe have not had significant business operations since formation and havegenerated no revenues from the production of oil or gas from our properties. Weare also subject to all of the risks inherent in attempting to expand arelatively new business venture. Such risks include, but are not limited to,the possible inability to profitably operate our existing properties orproperties to be acquired in the future, our possible inability to fully fundthe development requirements of such properties and our possible inability toacquire additional properties that will have a positive effect on ouroperations. We can provide no assurance that we will achieve a level ofprofitability that will provide a return on invested capital or that willresult in an increase in the market value of our securities. The experience ofour management team has primarily been in the exploration and productionindustry and we have limited experience in the power generation business. Weare initially relying on consultants and outside engineering and technicalfirms to provide the expertise to plan and execute the power generation aspectsof our strategy and we have not yet hired all necessary full-time employees tomanage this line of business. Accordingly, we are subject to the risk thatbecause of these factors and other general business risks noted throughoutthese “Risk Factors” we may not be able to profitably execute our powergeneration strategy.

 

***Weown rights to oil and gas properties that have not yet been developed.***Weown rights to oil and gas properties that have limited or no development. Thereare no guarantees that our properties will be developed profitably or that thepotential oil and gas resources on the property will produce as expected ifthey are developed.

 

***Werequire additional financing for the exploration and development of our foreignoil and gas properties and the construction of our proposed power generationfacility, pipeline and gas processing facility.***Withthe net proceeds from a $6 million private offering completed on September 30,2004, net proceeds from a $34.4 million private offering completed on July 19,2005, and net proceeds from a $5 million private offering completed on March10, 2006, we have begun to implement our plans to develop our existing oil andgas properties as discussed in “Management’s Discussion and Analysis and Planof Operation—Plan of Operation.” We anticipate the additional amounts requiredto fund our initial project will come primarily in the form of debt financing.In May 2005 the Company signed a Mandate Letter with International FinanceCorporation (“IFC”), a member of the World Bank Group based in Washington, D.C.The Mandate Letter specifies that the IFC will appraise BPZ Energy’s project inPeru to determine the feasibility and structure of a potential project financing.The IFC’s appraisal of the project will and has included a review of thetechnical, economic, commercial, financial, environmental and legal aspects ofthe project. The structure of any IFCfinancing will be defined during the appraisal process and anyIFC investment will depend on the project and the Company meeting IFC’sfinancing criteria, the overall financing plan being acceptable to IFC,approval of the investment by management and the Board of IFC, and theexecution of all appropriate documentation, in form and substance satisfactoryto IFC. Wedo not yet have a firm commitment from the IFC to finance the project andthere can be no assurance that we will receive financing from them. See “Management’sDiscussion and Analysis and Plan of Operation—Liquidity and Capital Resources”for further discussion. If we are unable to timely obtain adequate funds tofinance these expenditures, our ability to develop our oil and gas reserves maybe limited or substantially delayed. Such limitations or delays could result inthe potential loss of our oil and gas properties if we were unable to meet ourobligations under the license agreements. Inability to obtain funds also couldcause us to delay, scale back or abandon our plans for construction of ourpower generation facility, pipelines, and gas processing facility.

 

We anticipate that future amounts required tofund our foreign activities will be funded from debt financing, sale of equityinterests, joint venture arrangements, the sale of oil and gas interests,and/or future cash flows from operations. The exact nature and terms of suchfunding sources is unknown at this time, and there can be no assurance that wewill obtain such funding or have adequate funding available to finance ourfuture operations.

 

***Ourfuture operating revenue is dependent upon the performance of our properties.***Ourfuture operating revenue depends upon our ability to profitably operate ourexisting properties by drilling and completing wells that produce commercialquantities of gas and our ability to expand our operations through thesuccessful implementation of our plans to explore and acquire additionalproperties. The successful development of oil and gas properties requires anassessment of potential recoverable reserves, future oil and gas prices,operating costs, potential environmental and other liabilities and otherfactors. Such assessments are necessarily inexact. There can be no assurance thatonce in operation we can produce sufficient operating revenue to operate ourexisting properties or acquire additional oil and gas producing properties andleases. We may not discover or successfully produce any recoverable reserves,or we may not be able to make a profit from the reserves that we discover. Inthe event that we are unable to produce sufficient operating revenue to fundour future operations, we will be forced to seek additional, third-partyfunding, if such funding can be obtained. Such options would possibly includedebt financing, sale of equity interests in the Company, joint venturearrangements, or the sale of oil and gas interests. If we are unable to securesuch financing on a timely basis, we could be required to delay or scale backour operations. If such unavailability of funds continued for an extendedperiod of time, this could result in the termination of our operations and theloss of an investor’s entire investment.

 

***Ourbusiness involves many uncertainties and operating risks that may prevent usfrom realizing profits and can cause substantial losses.***Ourdevelopment activities may be unsuccessful for many reasons, including weather,the drilling of dry holes, cost overruns, equipment shortages and mechanicaldifficulties. Moreover, the successful drilling of a natural gas or oil welldoes not ensure we will realize a profit on our investment. A variety offactors, both geological and market-related, can cause a well to becomeuneconomical or only marginally economical. Our business involves a variety ofoperating risks, including:

 

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•fires;

•explosions;

•blow-outs and surface cratering;

•uncontrollable flows of natural gas, oil andformation water;

•natural disasters, such as hurricanes and otheradverse weather conditions;

•pipe, cement, subsea well or pipeline failures;

•casing collapses;

•mechanical difficulties, such as lost or stuck oilfield drilling and service tools;

•abnormally pressured formations;

•environmental hazards, such as natural gas leaks,oil spills, pipeline ruptures and discharges of toxic gases.

 

If we experience any of these problems, anywell bores, platforms, gathering systems and processing facilities could beaffected, which could adversely affect any drilling operations we may commence.

 

We could also incur substantial losses as aresult of:

 

•environmental hazards, such as natural gas leaks,oil spills, pipeline ruptures and discharges of toxic gases;

•injury or loss of life;

•severe damage to and destruction of property,natural resources and equipment;

•pollution and other environmental damage;

•clean-up responsibilities;

•regulatory investigation and penalties;

•suspension of our operations; and

•repairs to resume operations.

 

If any of these risks occur, and ourresulting losses are significant, we may have to curtail or suspend anydrilling or production operations we may eventually commence.

 

***Weplan to conduct offshore exploration, exploitation and production operationsoff the coast of northwest Peru, all of which are also subject to a variety ofoperating risks peculiar to the marine environment.***Suchrisks include capsizing, collisions and damage or loss from adverse weatherconditions or interference from commercial fishing activities. These conditionscan cause substantial damage to facilities and interrupt production. As aresult, we could incur substantial liabilities that could reduce or eliminatethe funds available for exploration, exploitation and acquisitions or result inloss of equipment and properties.

 

***Constructionand operation of power generation and gas processing facilities and pipelinesinvolve significant risks that cannot always be covered by insurance orcontractual protections.***The construction of powergeneration and gas processing facilities and pipelines involve many risks,including:

 

•supply interruptions,

•work stoppages,

•labor disputes,

•social unrest,

•inability to negotiate acceptable construction,supply or other contracts,

•inability to obtain required governmental permitsand approvals,

•weather interferences,

•unforeseen engineering, environmental and geologicalproblems, and

•unanticipated cost overruns.

 

The ongoing operation of these facilitiesinvolves all of the risks described above, in addition to risks relating to thebreakdown or failure of equipment or processes and performances below expectedlevels of output or efficiency. We intend to obtain and maintain commerciallyreasonable levels of insurance where such insurance is available and costeffective, obtain warranties from vendors and obligate contractors to meetcertain performance levels. However, the proceeds of any such insurance,warranties or performance guarantees may not be adequate to cover lost revenuesor increased expenses. Any of these risks could cause us to operate belowexpected capacity levels, which in turn could result in lost revenues,increased expense and higher maintenance costs.

 

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***Oursuccess depends on the existence and growth of markets for natural gas andelectricity in Peru and Ecuador.***Peru has arelatively well-developed and stable market for electricity, while the powermarket in Ecuador is not as well-developed or stable. Both countries rely on hydro-electricgenerating capacity for a significant portion of their power demand. Hydroplants are much less expensive to operate than plants which utilize naturalgas, but are subject to variable output based on rainfall and reservoir levels.The majority of the non-hydro, or thermal, power capacity in both countriesconsists of generating plants that utilize diesel or fuel oil, which aresignificantly more costly than natural gas at this time. Both countries havenatural gas reserves and production (although to a lesser extent in Ecuador),but neither has a well-developed natural gas infrastructure. Our immediatebusiness plan relies on the continued stability of the power market in Peru(and Ecuador for the purpose of gas sales to third-party power producers inEcuador) and our longer-term plans depend on the further development of theelectricity market in Ecuador. We are subject to the risks that relatively morefavorable business conditions for hydro plants or other competitive issues mayadversely affect the demand and prices for the electricity that we expect toproduce. We are also subject to the risks associated with potential disruptionsor changes to regulations of the natural gas or power markets in thesecountries. We plan to enter into long-term contracts to sell a significant partof our future power production. There is a market for long-term purchases ofpower and natural gas, but there can be no assurance that we will be successfulin obtaining such contracts on favorable terms. We will also be subject to thegeneral commercial issues related to being in the power business, including thecredit-worthiness of and collections from future customers and the ability toprofitably operate our future power plants.

 

***Thegeographic concentration of our properties in northwest Peru and southwestEcuador subjects us to an increased risk of loss of revenue or curtailment ofproduction from factors affecting that region specifically.***Thegeographic concentration of our properties in northwest Peru and southwestEcuador and adjacent waters means that some or all of our properties could beaffected by the same event should that region experience:

 

•severe weather (such as the effects of “El Nino”,which can cause excessive rainfall and flooding in Peru and Ecuador);

 

•delays or decreases in production, the availabilityof equipment, facilities or services;

 

•delays or decreases in the availability of capacityto transport, gather or process production; or

 

•changes in the regulatory environment.

 

Because all our properties could experiencethe same conditions at the same time, these conditions could have a relativelygreater impact on our results of operations than they might have on otheroperators who have properties over a wider geographic area.

 

***Instabilityof International Operations.***Presently, all of ouroil and gas properties are located in South America, specifically Peru andEcuador. The success and profitability of our international operations may beadversely affected by risks associated with international activities, includingeconomic, labor and social conditions, political instability, tax laws(including host-country export, excise and income taxes and U.S. taxes onforeign operations) and fluctuations in the value of the U.S. dollar versus thelocal currencies in which oil and gas producing activities may be conducted.This instability in laws, expenses of operations and fluctuations in exchangerates may make our assumptions about the economic viability of our oil and gasproperties incorrect. If these assumptions are incorrect, we may not be able toearn sufficient revenue to cover our costs of operations.

 

***Ouroperations in Peru and Ecuador involve substantial costs and are subject tocertain risks because the oil and gas industry in Peru and Ecuador is lessdeveloped than in the United States.***The oil andgas industries in Peru and Ecuador are not as developed as the oil and gasindustry in the United States. As a result, our drilling and developmentoperations in many instances will take longer to complete and may cost morethan similar operations in the United States. The availability of technicalexpertise, specific equipment and supplies may be more limited in Peru andEcuador than in the United States. Further, once oil and natural gas productionis recovered, there are fewer ways to transport it to market for sale. Pipelineand trucking operations are subject to uncertainty and lack of availability.Oil and natural gas pipelines and truck transport travel through miles ofterritory and are subject to the risk of diversion, destruction or delay. Weexpect that such factors will continue to subject our international operationsto economic and operating risks that companies with domestic operations do notexperience.

 

***Theunavailability or high cost of drilling rigs, equipment, supplies, personneland oil field services could adversely affect our ability to execute ourexploration and exploitation plans on a timely basis and within our budget.***Shortagesor the high cost of drilling rigs, equipment, supplies or personnel could delayor adversely affect our exploitation and exploration operations, which couldhave a material adverse effect on our business, financial condition or resultsof operations. If the unavailability or high cost of rigs, equipment, suppliesor personnel were particularly severe in Peru and Ecuador, we could bematerially and adversely affected because our operations and properties areconcentrated in those areas.

 

***Weare subject to numerous foreign laws and regulations of the oil and natural gasindustry that can adversely affect the cost, manner or feasibility of doingbusiness.***Our operations are subject to extensiveforeign laws and regulations relating to the exploration for and thedevelopment, production and transportation of oil and natural gas as well aselectrical power generation. Future laws or regulations, any adverse change inthe interpretation of existing laws or our failure to comply with

 

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existing legal requirements mayharm our results of operations and financial condition. We may be required tomake large and unanticipated capital expenditures to comply with governmentalregulations, such as:

 

•work program guarantees and other financialresponsibility requirements;

 

•taxation;

 

•royalty requirements;

 

•customer requirements;

 

•operational reporting; and

 

•safety requirements.

 

Under these laws and regulations, we could beliable for:

 

•personal injuries; and

 

•property and natural resource damages; and

 

•governmental infringements and sanctions.

 

***Ifwe fail to comply with the terms of certain contracts related to our foreignoperations, we could lose our rights under each of those contracts.***Theterms of each of our contracts with the government of Peru, including ourPeruvian license contracts and technical evaluation agreements, require that weperform certain activities, such as seismic interpretations and the drilling ofrequired wells in accordance with those contracts and agreements. Our failureto timely perform those activities as required could result in the loss of ourrights under a particular contract or the loss of the amounts we have posted asa guaranty for the performance of such activities, which would likely result ina significant loss to us.

 

***Weare subject to complex environmental regulatory and permitting laws andregulations that can adversely affect the cost, manner and feasibility of ourplanned operations.***The development, productionand sale of oil and gas in South America are subject to extensive environmentallaws and regulations. Our ability to conduct continued operations is subject tosatisfying applicable regulatory and permitting controls. For example, we arerequired to obtain an environmental permit or approval from the government inPeru prior to conducting seismic operations, drilling a well or constructing apipeline in Peruvian territory, including the waters in offshore Peru, where weintend to conduct future oil and gas operations. Failure to comply with these lawsand regulations also may result in the suspension or termination of our planneddrilling operations and subject us to administrative, civil and criminalpenalties.

 

Our current permits and authorizations andour ability to get future permits and authorizations may, over time, besusceptible to increased scrutiny, resulting in increased costs, or delays inreceiving appropriate authorizations. In particular, we may experience delaysin obtaining permits and authorizations in Peru and Ecuador necessary for ouroperations. Compliance with these laws and regulations may increase our costsof operations, as well as further restrict our foreign operations. Moreover,these laws and regulations could change in ways that substantially increase ourcosts. These laws and regulations have changed in the past and have generallyimposed more stringent requirements that increase operating costs or requirecapital expenditures in order to remain in compliance. It is also possible thatunanticipated developments could cause us to make environmental expendituresthat are significantly higher from those we currently anticipate, therebyincreasing our overall costs. Failure to comply with new regulations couldcause us to suspend or terminate certain operations or subject us toadministrative, civil and criminal penalties. Any of these liabilities,penalties, suspensions, terminations or regulatory changes could materiallyadversely affect our financial condition and our ability to implement our planof operation.

 

***Compliancewith, or breach of, laws relating to the discharge of materials into, and theprotection of the environment, can be costly and could limit our operations.***Asan owner or lessee and operator of oil and gas properties in Peru and Ecuador,we are subject to various national, state and local laws and regulationsrelating to discharge of materials into, and protection of, the environment.These laws and regulations may, among other things, impose liability on theowner or lessee under an oil and gas lease for the cost of property damage, oilspills, discharge of hazardous materials, remediation and clean-up resultingfrom operations, subject the owner or lessee to liability for pollution damagesand other environmental damages, and require suspension or cessation ofoperations in affected areas.

 

We have established practices for continuedcompliance with environmental laws and regulations. We believe the costsincurred by these policies and procedures are necessary business costs in theoil and gas industry. There is no assurance that changes in or additions tolaws or regulations regarding the protection of the environment will notincrease such compliance costs, or have a material adverse effect upon ourcapital expenditures, earnings or competitive position.

 

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***Ouroil and gas operations involve substantial costs and are subject to variouseconomic risks.***Our oil and gas operations aresubject to the economic risks typically associated with exploration, developmentand production activities, including the necessity of significant expendituresto locate and acquire producing properties and to drill exploratory wells. Thecost and length of time necessary to produce any reserves may be such that itwill not be economically viable. In conducting exploration and developmentactivities, the presence of unanticipated pressure or irregularities informations, miscalculations or accidents may cause our exploration, developmentand production activities to be unsuccessful. We also face the risk that theoil and/or gas reserves may be less than anticipated, that we will not havesufficient funds to successfully drill on the property, that we will not beable to market the oil and/or gas due to a lack of a market and that fluctuationsin the prices of oil and/or gas will make development of those leasesuneconomical. This could result in a total loss of our investment. In addition,the cost and timing of drilling, completing and operating wells is oftenuncertain.

 

***Competitionfor oil and natural gas properties and prospects is intense; some of ourcompetitors have larger financial, technical and personnel resources that givethem an advantage in evaluating and obtaining properties and prospects.***Weoperate in a highly competitive environment for reviewing prospects, acquiringproperties, marketing oil and natural gas and securing trained personnel andequipment. In addition, changes in Peruvian government regulation have enabledmultinational and regional companies to enter the Peruvian energy market.Competition in our business activities has increased and will increase further,as existing and new participants expand their activities as a result of theseregulatory changes. Many of our competitors possess and employ financial resourcesthat allow them to obtain substantially greater technical and personnelresources than we have. We actively compete with other companies in ourindustry when acquiring new leases or oil and gas properties. For example,Perupetro may choose to call for bids, either through international competitivebiddings or through private bidding processes by invitation, if severalcompanies are interested in an area, and award the contract to the highestbidder. These additional resources can be particularly important in reviewingprospects and purchasing properties. Our competitors may be able to evaluate,bid for and purchase a greater number of properties and prospects than ourfinancial or personnel resources permit. Our competitors may also be able to paymore for productive oil and natural gas properties and exploratory prospectsthan we are able or willing to pay. On the acquisition opportunities madeavailable to us, we compete with other companies in our industry for propertiesoperated by third parties through a private bidding process, directnegotiations or some combination thereof. Our ability to acquire additionalprospects and to find and develop reserves in the future will depend on ourability to evaluate and select suitable properties and to consummatetransactions in a highly competitive environment. If we are unable to competesuccessfully in these areas in the future, our future revenues and growth maybe diminished or restricted. The availability of properties for acquisitiondepends largely on the divesting practices of other oil and natural gascompanies, commodity prices, general economic conditions and other factors wecannot control or influence.

 

***Theloss of senior management or key technical personnel could adversely affect us.***We have engaged certain members of management whohave substantial expertise in the type of endeavors that we presently conduct.We do not maintain any life insurance against the loss of any of theseindividuals. To the extent that their services become unavailable, we will berequired to retain other qualified personnel. There can be no assurance that wewill be able to recruit and hire qualified persons upon acceptable terms.

 

Similarly, the oil and gas explorationindustry requires the use of personnel with substantial technical expertise. Inthe event that the services of our current technical personnel becomeunavailable, we will need to hire qualified personnel to take their place. Noassurance can be given that we will be able to recruit and hire such persons onacceptable terms.

 

***Insurancedoes not cover all risks.***Exploration for andproduction of oil and natural gas can be hazardous, involving unforeseenoccurrences such as blowouts, cratering, fires and loss of well control, whichcan result in damage to or destruction of wells or production facilities,formations, injury to persons, loss of life, or damage to property or theenvironment. Even if we are able to secure additional financing, we may nothave sufficient capital to establish any reserves for contingent liabilities orworkovers. We do not presently maintain insurance against losses or liabilitiesarising from our operations or for environmental coverage. However, we are inthe process of evaluating insurance coverage in amountsconsistent with our business activities and to the extent required by ourlicense contracts.No such insurance coverage can insure for all operational or environmentalrisks. The occurrence of an event that is not insured or not fully insuredcould result in losses to us. For example, uninsured environmental damages,property damages or damages related to personal injuries could divert capitalneeded to implement our plan of operation. If any such uninsured losses aresignificant, we may have to curtail or suspend our drilling operations untilsuch time as replacement capital is obtained, if ever.

 

***Asubstantial or extended decline in oil and natural gas prices may adverselyaffect our business, financial condition, cash flow, liquidity or results ofoperations and our ability to meet our capital expenditure obligations andfinancial commitments to implement our business plan.***Withrespect to our oil and gas business, any revenues, cash flow, profitability andfuture rate of growth we achieve will be greatly dependent upon prevailingprices for oil and gas. Our ability to maintain or increase our borrowingcapacity and to obtain additional capital on attractive terms is also expectedto be dependent on oil and gas prices. Oil and natural gas are commodities,and, therefore, their prices are subject to wide fluctuations in response torelatively minor changes in supply and demand. Historically, oil and gas pricesand markets have been volatile and are likely to continue to be volatile in thefuture. Prices for oil and gas are subject to potentially wide fluctuations inresponse to relatively minor changes in

 

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supply of and demand for oiland gas, market uncertainty, and a variety of additional factors that arebeyond our control. Those factors include:

 

•international political conditions (including warsand civil unrest);

 

•the domestic and foreign supply of oil and gas;

 

•the level of consumer demand;

 

•weather conditions;

 

•domestic and foreign governmental regulations and otheractions;

 

•actions taken by the Organization of PetroleumExporting Countries (OPEC);

 

•the price and availability of alternative fuels; and

 

•overall economic conditions.

 

Lower oil and natural gas prices may not onlydecrease our revenues on a per unit basis, but may also reduce the amount ofoil and natural gas we can produce economically, if any. A substantial orextended decline in oil and natural gas prices may materially affect our futurebusiness, financial condition, results of operations, liquidity and borrowingcapacity we may have and may require a reduction in the carrying value of ouroil and gas properties. While our revenues may increase if prevailing oil andgas prices increase significantly, exploration and productioncosts and acquisition costs for additional propertiesand reserves may also increase.

 

***Wemay not be able to develop a proven reserve base.***Ourfuture success will depend upon our ability to find, acquire and develop oiland gas reserves that are economically recoverable. Any reserves we developwill decline as they are produced, except to the extent that we conductsuccessful revitalization activities, or are able to acquire propertiescontaining proven reserves, or both. To develop reserves and production, wemust implement our development and production programs, identify and producepreviously overlooked or by-passed zones and shut-in wells, acquire additionalproperties or undertake other replacement activities. Our current strategy isto develop a reserve base, production and cash flow through the development ofoil and gas fields to which we have development rights and selectiveacquisitions of other desirable oil and gas properties where we can utilize newand existing technology. We can give no assurance that our planned development,revitalization, and acquisition activities will result in significant reservesor that we will have success in discovering and producing reserves ateconomical exploration and development costs. We may not be able to locategeologically satisfactory property, particularly since we will be competing forsuch property with other oil and gas companies, most of which have much greaterfinancial resources than ourselves. Moreover, even if desirable properties areavailable to us, we may not have sufficient funds with which to acquireadditional leases.

 

**RisksRelating to Our Common Stock**

 

***Investorprofits, if any, may be limited for the near future.***Inthe past, we have never paid a dividend. We do not anticipate paying anydividends in the near future. Accordingly, investors in our common stock maynot derive any profits from their investment in us for the foreseeable future,other than through any price appreciation of our common stock that may occur.Further, any appreciation in the price of our common stock may be limited ornonexistent as long as we continue to have operating losses. We have not beenprofitable and have accumulated deficits during the developmentstage totaling $19,582,418 through December 31, 2005. To date wehave not had any revenue or earnings from operations, and we will continue, inall likelihood, to sustain operating expenses without corresponding revenuesuntil we are able to successfully implement our plan of operation, if ever.

 

***Becauseour common stock may be subject to the “penny stock” regulations, its liquiditymay be reduced.***Generally, penny stocks are equitysecurities (i) with a price of less than $5.00 per share; (ii) that are nottraded on a “recognized” national exchange or whose prices are notquoted on the Nasdaq automated quotation system; or (iii)of issuers with net tangible assets less than $2.0 million (if the issuer hasbeen in continuous operation for at least three years), or with averagerevenues of less than $6.0 million for the last three years. The penny stockrules require a broker/dealer to deliver, prior to a transaction in a pennystock, a standardized risk disclosure document prescribed by the SEC and toprovide the potential purchaser of penny stock with the following information:

 

•information about penny stocks;

 

•the nature and level of risk in the penny stockmarket;

 

•the bid and offer quotations for the stock; and

 

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•other burdensome and detailed information.

 

Those delivery and disclosure requirementstend to reduce the level of interest of broker/dealers in dealing with pennystocks, which could have the effect of reducing the level of trading activityin the secondary market for our common stock during the time that our commonstock is subject to the penny stock regulations. Our common stock is not quotedon a national stock exchange or NASDAQ and would likelybe considered a penny stock subject to the penny stock regulations if the priceof our common stock remains below $5.00 and we are not subject to any otherexemptions. This could reduce the liquidity of our common stock and make itmore difficult for investors to sell our common stock.

 

***Additionalinfusions of capital may have a dilutive effect on existing shareholders.***Tofinance our operations we may sell additional shares of our stock. Anyadditional equity financing that we receive may involve substantial dilution toour then-existing shareholders. Furthermore, we may issue stock to acquireproperties, assets, or businesses. In the event that any such shares areissued, the proportionate ownership and voting power of other shareholders willbe reduced.

 

***Shareseligible for future sale by our current shareholders may impair our ability toraise capital through the sale of our stock.***As ofDecember31, 2005, we had 40,349,979 shares of commonstockissued, of which 39,889,529 were deemed to be outstanding. Inaddition, we have 13,046,652 of other potentially dilutivesecurities, including an additional 9,000,000 common shares which may beissued to the former shareholders of BPZ-Texas on an earn-outbasis if we achieve certain production goals prior to December 31, 2007. Thepossibility that substantial amounts of shares of our common stock may be soldin the public market may cause prevailing market prices for our common stock todecrease and thus could impair our ability to raise capital through the sale ofour equity securities.

 

***Weare controlled by our officers, directors and entities affiliated with them.***Inthe aggregate, our management and directors own or control approximately 34.6%of our common stock issued as of December 31,2005. These shareholders, if acting together, will be able to significantlyinfluence all matters requiring approval by our shareholders, including theelection of directors and the approval of mergers or other business combinationtransactions.

 

**Item 2. Description of Properties**

 

**Offices**

 

Our corporate headquarters office is in Houston, Texas, where we leaseapproximately 7,770 square feet of office space under a five-year lease whichexpires on September 30, 2010. We also maintain an administrative office inLima, Peru of approximately 3,700 square feet under a month-to-monthlease.

 

**BPZ’s Properties in Peru**

 

We currently have rights to three properties in northwestPeru. We have a 100% working interest in license contracts for Block Z-1 andBlock XIX. Thelicense contracts afford an initial exploration period of seven to ten yearsand, if explorationefforts are successful, provide a total contract term of 40 years for gasdevelopment and production and 30 yearsfor oil development andproduction. We also have a Technical Evaluation Agreement covering Area VI.This agreementgivesus the right to conduct technical evaluations of the area over a 24-month period andthe exclusive right to enter into alicensecontract if the evaluations indicatethe potential for successfuloperations. We recently initiated negotiations to obtain a license contract forArea VI. These three blocks cover a combined area of approximately 2.7 million acres. InDecember 2005, we notified Perupetro that we did not intend to pursue a licensecontract on Area XVI, which had been covered by aTechnical EvaluationAgreement.

 

The following table is the Company’sundeveloped properties in Northwest Peru as of December 31, 2005:

 
| **CONTRACT / AGREEMENT** | ** ** | **BASIN**     | ** ** | **AREA(c)** | ** ** | **BPZ’s ****Ownership** | ** ** |
|------------------------------------|------------|---------------|------------|-------------|------------|-----------------------------------|------------|
| ** **                         | ** ** | ** **    | ** ** | **(acres)** | ** ** | **(%)**                           | ** ** |
| Block Z-1(a)                       |       | Tumbes        |       | 739,205     |       | 100                               | %          |
| Block XIX(a)                       |       | Tumbes/Talara |       | 472,860     |       | 100                               | %          |
| Area VI(b)                         |       | Lancones      |       | 1,443,561   |       | 100                               | %          |
| Total                              |       |          |       | 2,655,626   |       |                              |       |

 

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(a)                                  License Contract

(b)                                 Technical EvaluationAgreement

(c)                                  All acreage is consideredundeveloped

 

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**Descriptionof Block Z-1 and License Contract**

 

Block Z-1, a coastal offshore area encompassing 739,205 acres, issituated at the southern end of the Gulf of Guayaquil in northwest Peru.Geologically, the block lies within the Tumbes basin. From the coastline, waterdepths increase gradually. The average water depth of the area is approximately200 feet and only 10% of the area has depths greater than 500 feet. There are five structures which weredrilled in the 1970’s and 1980’s by previous operators, including Tenneco, Inc.and Belco Petroleum Corporation. These structures are known as the Albacora, Barracuda, Corvina, Delfin and PiedraRedonda fields. Wells drilled in each of these structures encounteredhydrocarbons, principally natural gas, while drilling at depths ranging from6,000 to 12,000 feet. However, at the time the wells were drilled, it was notconsidered economic to produce and sell natural gas from the fields.Accordingly, the wells were either suspended or abandoned.

 

BPZ originally acquired its initial interest in Block Z-1 in a jointventure with Syntroleum Corporation, under an exploration and productionlicense contract dated November 30, 2001, with an effective date of January 29,2002. Under the original contract, BPZ owned a 5% non-operating workinginterest in the block. Syntroleum later transferred its 95% interest to NuevoEnergy, Inc. Subsequent to the merger of Nuevo Energy, Inc. and PlainsExploration and Production Company, Nuevo Energy, Inc. transferred its interestin Block Z-1 to BPZ who then assumed a 100% working interest, as well as theremaining obligations under the contract. Perupetro approved the assumption ofNuevo’s interest by BPZ and the designation of BPZ as a qualified operatorunder the contract in November 2004. Such action was subject to officialratification and issuance of a Supreme Decree by the government of Peru, whichwas received on February 3, 2005. Accordingly, an amended contract was signedwith Perupetro, which named BPZ as the owner of 100% of the participation underthe license contract.

 

The license contract provides for an initial exploration phase of sevenyears, which is divided into four periods, and can be extended under certaincircumstances for an additional six years. Each period has a commitment forexploration activities and requires a financial guarantee to secure theperformance of the work commitment during such period. Block Z-1 is currentlyin the second exploration period which will last for 18 months, ending in July 2006, unlessan extension of up to six months to complete the work commitment is requested. During the secondexploration period, we must drill at least oneexploratory well or acquire 300 square kilometers of 3-D seismic data. We posted a $1.3 millionperformance bond in January 2005 in connection with the second explorationperiod. The third exploration period is scheduled to begin in July 2006 andexpire in January 2008 and will require the drilling of an additionalexploratory well, or other equivalent work commitments, and will require aperformance bond of $1.0 million. The fourth and final exploration period isscheduled to begin in January 2008 and expire in January 2009. It will alsorequire the drilling of an additional exploratory well, or other equivalentwork commitments, and will require a performance bond of $1.0 million. Theperformance bond amounts are not cumulative, and are released at the end of eachexploration period if the work commitment for that period has been satisfied. Inaddition, wearerequired to make technology transfer payments related to training costs ofPerupetro professional staff during the exploration phase of $50,000 per year.

 

The exploitation, or development, period of the contract will commenceas soon as we declare a commercial discovery andreceives approval for a field development plan. We must declare a commercialdiscovery no later than the end of the last exploration period, including anyextensions or deferments. Under the contract, oil development and production can continue fora total of 30 years from the effective date of the contract, and gas development and production can continue for40 years. Royalties under the contract vary from 5% to 20% based on productionvolumes.

 

**Descriptionof Block XIX and License Contract**

 

Block XIX covers approximately 472,860 acres, lying entirely onshoreand adjacent to Block Z-1 in northwest Peru. Geologically, the block liesprimarily within the Tumbes basin of Oligocene-Neogene age, but also coverspart of the Talara Basin to the south.

 

In February 2003, we entered into a TechnicalEvaluation Agreement with Perupetro for Block XIX. In December 2003, we signed a license contractwhereby we acquired a 100% interest in Block XIX. The term for the explorationperiod is seven years and can be extended under certain circumstances for an additionalperiod of up to four years. If a commercial discovery is made during theexploration period, the contract will allow for the development and production of oil for aperiod of 30 years from the effective date and the development and production of gas for aperiod of 40 years. Royalties under the contract vary from 5% to 20% based onproduction volumes.

 

The seven year exploration phase is divided into five periods of 18months, 24 months, 15 months, 15 months and 12 months, respectively. We are currently in the second exploration period which isscheduled to end in August2007,unless an extension of up to six months to complete the work commitment isrequested. During the second exploration period, we arerequired to acquire and interpret 100 kilometers of new 2-D seismic data and toconduct certain integratedgeological, geophysical, and geochemical and reservoir engineeringevaluation studies. In connection with the second exploration period, we posted a $350,000 performance bondin August 2005. The third exploration period is scheduled to begin in August 2007 and will require aperformance bond of $585,000. The fourth exploration period is scheduled tobegin in November 2008 and will require aperformance bond of $585,000. The fifth and final exploration period isscheduled to begin in February 2009 and will require aperformance bond of $585,000. The performance bond amounts are not cumulative,and are released atthe end of each exploration period if the work commitment forthat period has been satisfied. In addition, we are required to make technologytransfer

 

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payments related to training costs of Perupetro professional staffduring the exploration phase of $5,000 per year. The exploitation, ordevelopment, period of the contract will commence as soon as the Companydeclares a commercial discovery and receives approval for a field developmentplan. We must declare a commercial discovery no later than the endof the last exploration period, including any extensions or deferments.

 

**Descriptionof Area VI and Technical Evaluation Agreement**

 

Area VI is located onshore in northwest Peru within the Lancones Basinof Cretaceous—Upper Eocene Age and covers an area of approximately 1,443,561acres. The Lancones Basin is primarily an exploratory area and has had limiteddrilling and seismic activity.

 

In December 2003, we entered into a TechnicalEvaluation Agreement for Area VI. The agreement enables us to perform technicalstudies based on existing information, applying new concepts, newinterpretations and new exploration models, with the objective of obtainingevidence of potential exploratory success under a license contract. Theagreement covers a period of 24 months. At the end of this period, we have the exclusive right to obtain a licensecontract covering the area. In connection with the signing of this Agreement, we posted a $20,000performance bond. In addition, weareobligated to arrange for technology transfer to Perupetro professional staff.The costs associated with this training are expected to be less than $10,000. During the fourth quarter of2005, we notified Perupetro that we intend to negotiate a license contractcovering this area.

 

**Oiland Gas Resources**

 

During 2004, we retained Gaffney Cline & Associates, Inc. (“GCA”), aninternationally recognized firm of independent reserve engineers, to evaluatethe oil and gas resource potential of the Corvina and Piedra Redonda Fieldslocated in the Block Z-1 license contract area. GCA focused its evaluation onthe wells which were drilled by previous operators of Block Z-1, and theseismic and other geological and geophysical data available on the block.

 

In the Corvina Field, seven wells were drilled, including two wellsdrilled by Tenneco, Inc. in the mid-1970’s and five wells drilled by Belco PetroleumCorporation (“Belco”) in the early 1980’s. Two drilling and productionplatforms were set up during this period and are still in place in the CorvinaField. The platforms need to be repaired and refurbished, but are structurallysound and we believe they are suitable for our future operations. We havehired a contractor to undertake the refurbishment of one of the platforms andhave initiated work on this project. All seven wells in the CorvinaField encountered indications of natural gas and apparent reservoir-qualityformations,although only one of the wells, the CX11-16X, was completed and tested. At the time these wellswere drilled, there was no commercial market for natural gas in the region. The CX11-16X produced naturalgas at rates as high as 16.6 million cubic feet of gas per day (“MMcf/d”)during two separate tests over a period of approximately 20 days each. The wellwas temporarily abandoned. We believe this well can be reestablished as aproducing well.

 

In the Piedra Redonda Field, two wells were drilled by Belco in the early1980’s. Indications of natural gas were present in both wells. One well wascompleted, while the other well encountered abnormally high pressures and wasabandoned prior to reaching its intended total depth. There is also a drillingand production platform in place in the Piedra Redonda Field. The completedwell in the Piedra Redonda Field, the C18X, produced natural gas at rates ashigh as 8.3 MMcf/d over a period of approximately 20 days during an extendedtest in 1979 and was also temporarily abandoned. We believe this well can bereestablished as a producing well.

 

GCA reviewed all available technical data, including a large volume of2-D seismic data, well logs, drilling and completion reports, well testinformation, and other geological and geophysical data and analysis. TheCompany intends to develop these resources as discussed in “Management’sDiscussion and Analysis and Plan of Operation.” The development of theseresources will require a significant financial investment which is presentlyestimated to be in excess of $112 million. We do notcurrently have the financial capacity or commitments for a development programof this magnitude. Accordingly, the Company has not disclosed amounts of provedreserves in its SEC filings. At such time as we obtain sufficient financialcommitments to proceed with the full development of Block Z-1 and all otherconditions necessary to record proved reserves are met, we expect to record SECproved reserves and disclose such reserves in future SEC filings as permittedby SEC rules.

 

**BPZ’s Properties in Ecuador**

 

In June 2004, we acquired the common stock of SMC Ecuador, Inc., aDelaware corporation, the owner of a 10% interest in a non-operated producing oil and gas property located in the Republic ofEcuador (the “Santa Elena Property”). The Santa Elena Property is located westof the city of Guayaquil along the coast of Ecuador. The license contractprovides for royalty payments equal to 23% of production. There have beenalmost 3,000 wells drilled in the field since production began in the 1920’s.Currently, there are approximately 1,250 active wells which produceapproximately 2,000 barrels of oil per day. The majority of the wells produceintermittently by gas lift, mechanical pump or swabbing techniques. Crude oilis gathered in holding tanks and pumped via pipeline to an oil refinery in thecity of Libertad, Ecuador.

 

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**Item 3. Legal Proceedings**

 

Navidec was advisedin February 2004 that the SEC was conducting an informal inquiry to determinewhether Navidec had violated federal securities laws. The SEC made an informalrequest that Navidec voluntarily produce certain documents, which were providedto the SEC in May 2004. Based on the inquiries made and the informationrequested, we believe the SEC’s investigationrelates, at least in part, to the restatement of Navidec’s reported earnings for thefirst and second quarters of 2003. This restatement was reportedin Navidec’s Form 10-Q for the third quarter of 2003 filed on December 11,2003.

 

In December 2004, we received notice that theSEC had issued an Order Directing a Private Investigation and DesignatingOfficers to Take Testimony, and would be conducting a formal investigation. Weare cooperating fully with the SEC inthis matter. As of December 31, 2005, a total of approximately $50,000, primarily in legal fees,had been incurred in connection with the SEC investigation. Pursuant to theMerger agreement,we havebeen indemnified by NFS for the costs of the SEC investigation and NFS has borne the costsincurred to date. We are not aware of the future actions, if any, which the SEC intends to pursue inthis matter, but no assurance can be given that the investigation will beresolved without negativeconsequences to the Company.

 

In February 2006, we filed a petition in theDistrict Court of Arapahoe County, Colorado for the judicial dissolution ofNavidec Financial Services, Inc. (“NFS”) and the appointment of a receiver forNFS. BPZ is seeking this action on behalf of those shareholders entitled to thespin-off of NFS shares pursuant to the Merger Agreement with Navidec, Inc.dated July 8, 2004. Despite the fact that the Merger was consummated in September2004, the spin-off has not occurred and it appears highly unlikely orimpossible that it will be completed. BPZ is the record owner of approximately65% of the common shares of NFS, although the pre-merger shareholders ofNavidec, Inc. are the ultimate beneficiaries of the spin-off. Accordingly, BPZclaims no beneficial interest in NFS. The directors of BPZ believe that theliquidation of NFS and distribution of the net cash value to the beneficialowners is the most viable option to accomplish the intent and spirit of thespin-off and is the best financial alternative for such owners. Additionally,we believe that the appointment of a receiver is necessary to independentlymanage and wind-up the affairs of NFS. This matter is being contested by NFSand we cannot predict the outcome or timing of this matter

 

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

 

There were no matters submitted toa vote of stockholders during the fourth quarter of the fiscal year covered bythis Annual Report.

 

# **PART II**

#  

**Item 5. Market forCommon Equity and Related Stockholder Matters**

 

**Market Information**

 

Prior to June 5,2002, our common stock was traded on the Nasdaq National Market under thesymbol “NVDC”. On that date, we commenced trading on the Nasdaq Small Cap Market.On August 18, 2003 Navidec received notice from the Nasdaq Small Cap Marketthat it was not in compliance with the rules regarding the minimum requirementsfor stockholders’ equity. As a result, it began trading on the OTC BulletinBoard under the same symbol on August 20, 2003. In connection with the Merger,we changed our name to BPZ Energy, Inc. and began trading under the symbol “BPZI”on February 7, 2005, also on the OTC Bulletin Board. On December27, 2005, as a result of a delay in filing our quarterly report on Form 10-Qfor the quarterly period ended September 30, 2005, we became ineligible fortrading on the OTC Bulletin Board and began trading over the counter on thePink Sheets under the symbol “BPZI.”

 

The following tablesets forth, for the periods indicated, the high and low prices of a share ofour common stock as reported on the Nasdaq National Market, Nasdaq Small CapMarket, OTC Bulletin Board and the OTC Pink Sheets for the applicable timeperiods. The quotations provided for the OTC markets reflect interdealer priceswithout retail mark-up, mark-down or commissions, and may not represent actualtransactions.

 
| ** **      | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------|------------|----------|------------|---------|------------|
| **2005**        |       |     |       |    |       |
| Fourth  quarter |       | $        | 5.05       |    | $          | 1.01 |   |
| Third  quarter  |       | 6.00     |       | 4.00    |       |
| Second quarter  |       | 6.50     |       | 3.70    |       |
| First quarter   |       | 6.90     |       | 3.20    |       |
| **2004**        |       |     |       |    |       |
| Fourth quarter  |       | 5.60     |       | 2.90    |       |
| Third quarter   |       | 3.75     |       | 1.25    |       |
| Second quarter  |       | 2.05     |       | 1.10    |       |
| First quarter   |       | 1.25     |       | 0.98    |       |
|                 |            |          |            |         |            |  |  |

 

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**Holders**

 

As of December 31, 2005, we had approximately 328 shareholders of record,plus an estimated 2,650 beneficial owners of our common stock.

 

**Dividend Policy on Common Stock**

 

We have never paidcash dividends on our stock. For the foreseeable future, we intend to retainearnings, if any, to meet our working capital requirements and to financefuture operations. Accordingly, we do not plan to declare or distribute cashdividends to the holders of our common stock in the foreseeable future.

 

**EquityCompensation Plan**

 

The BPZ Energy, Inc. 2005 Long-TermIncentive Compensation Plan (the “LTIP” or “Plan”) permits the Board ofDirectors to award eligible employees, directors and consultants withincentive-based and non-incentive-based compensation.  See Note 9 to the Consolidated FinancialStatements for further details about this Plan.

 

**RecentSales of Unregistered Securities**

 

On January 30,2004,prior to the Merger, Navidec, Inc. closed a private placement of 564,500 units at $1 perunit, for total gross proceeds of $564,500. Each unit consisted of one common share, one “A”Warrant exercisable at $2.00 per share and one “B” Warrant exercisable at $4.00per share.

 

In July 2004, in connection with aDirector’s Agreement, the Company issued options to acquire up to 1,000,000shares of the Company’s common stock at an exercise price of $1.30 per share tothe former Chief Executive Officer of Navidec, Inc., who was at the time adirector of the Company. See Note 9 to the Consolidated Financial Statements forfurther details about this stock option issuance.

 

On September 10, 2004, in connection with the Mergerof Navidec and BPZ-Texas, the Company issued 9,000,000 shares of common stockin a stock for stock exchange to the shareholders of BPZ-Texas. This transaction is morefully described in “Description of Business – Navidec Merger Transaction”included herein. Also in connection with the Merger, the Company issued 662,149 shares of common stock toNavidec Financial Services,Inc.(“NFS”), anaffiliate of the Company.

 

Pursuant to a Business Consulting Agreemententered into in connection with the Merger, the Company issued to NFS, anaffiliate of the Company, fully vested warrants to purchase 1,500,000 shares ofcommon stock at an exercise price of $2.00 per share. Such warrants expire onJuly 31, 2006. See Note 9 to the Consolidated Financial Statements forfurther details about this transaction.

 

On September 29,2004, the Company issued 500,000 shares of common stock to an individual inexchange for the retirement of $1,020,529 of debt.

 

As of September 30,2004, the Company closed a private placement of common stock for cash thatbegan on July 27, 2004. The offering raised a total of $6,000,000 in grossproceeds through the sale of 3,000,000 common shares at a price of $2.00 pershare to a total of 78 accredited investors. The proceeds of theoffering were approximately $5,507,000 after deducting placement agent fees of$360,000 and other offering expenses of $133,000. The primary placement agent was SpencerEdwards Investments, Inc. of Denver, Colorado, which placed 1,534,450 shares,or 51% of the offering.  Also, Moloney Securities Co., Inc. of St. Louis,Missouri placed 395,000 shares, or 13% of the offering and Neidiger, Tucker,Bruner, Inc. of Denver, Colorado placed 320,000 shares, or 11% of the offering. The remaining shares, totaling 750,550 shares, were placed without an agent.

 

On July 1, 2005 the Company issued9,000,000 shares of common stock to the former shareholders of BPZ-Texas inconnection with earn-out provisions in the Merger Agreement. This transactionis more fully described in “Description of Business – Navidec MergerTransaction” included herein.

 

On July 1, 2005, the Company issued250,000 shares of common stock to acquire a 4% net working interest in theSanta Elena Property in Ecuador from an individual who had received theinterest in connection with financing provided to the Company for the originalacquisition of the property in June 2004.

 

On July 19, 2005,the Company completed a private placement of 11,466,000 shares of common stockto pursuant to a Stock Purchase Agreement dated July 19, 2005. The common stockwas priced at $3.00 per share, which resulted in gross proceeds to theCompany of approximately $34.4 million. Net proceeds from the private placementwere $31.9 million. For its servicesas placement agent in connection with the transaction, Morgan Keegan &Company, Inc. received 7% of the gross proceeds from the offering and warrants to purchase100,000 shares of the Company’s common stock at an exercise price of $3.00 pershare. Such warrants expire on July 19, 2010.

 

On September 30, 2005, the Companyissued 15,000 shares of common stock to an individual for financial managementand consulting services performed.

 

On December 17, 2005, the Companyissued 92,705 shares of common stock in lieu of cash to which the investorswould have otherwise been entitled pursuant to delays in the effectiveness ofthe Company registration statement in connection with the private placement ofcommon stock on July 19, 2005. See Note 9 to the Consolidated FinancialStatements for further details about this transaction.

 

On December 31, 2005 the Company issued 20,000 shares ofcommon stock to an individual for legal consulting services performed.

 

The foregoing issuances of common stock were made in reliance upon the exemption from registration set forth in

 

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Section 4(2) of theSecurities Act of 1933 for transactions not involving a public offering. Nounderwriters were engaged in connection with the foregoing issuances ofsecurities. The sales were made without general solicitation or advertising. Eachpurchaser was an “accredited investor” or a sophisticated investor with accessto all relevant information necessary to evaluate the investment whorepresented to the Company that the sales were being acquired for investment.

 

**Item6. Management’s Discussion and Analysis and Plan of Operation**

 

***SEE RISK FACTORS IN ITEM 1 “DESCRIPTION OF BUSINESS” OF THIS ANNUALREPORT FORM 10-KSB***

 

**Resultsof Operations**

 

We are in the early stage of developing our properties in Peru and donot currently have any production or revenues from these properties. Ouroperations to date have been limited to technical evaluation of the propertiesand the design of development plans to exploit the oil and gas resources onthose properties.

 

Our operating and administrative expenses to date have consistedprincipally of general and administrative costs and geological, geophysical andengineering costs. General and administrative costs have increasedsignificantly from $1,752,927 during 2004 to $4,422,747 during 2005 as a resultof our increased activity levels, additional personnel and costs associatedwith being a public company. We incurred $998,131 of geological, geophysicaland engineering costs in 2005 primarily related to our Block Z-1 gas-to-powerproject, compared to $360,965 in 2004.

 

Also, during 2005, we incurred $1,382,479, in stock-based compensationas a result of amortizing the deferred compensation expense related to(i) a grant of 150,000 shares of restricted common stock to ourindependent directors; (ii) a grant of 970,000 shares of restricted commonstock to three of our officers; (iii) 500,000 stock options issued to theformer CEO of Navidec. During 2004, we recorded stock-based compensationexpense of $4,414,935 primarily as a result of shares issued for services toemployees and consultants of BPZ-Texas prior to the Merger.

 

For the year ended December 31, 2005 werecorded a loss attributable to our equity ownership of NFS in the amount of $2,156,859.As of December 31, 2005, BPZ’s investment in NFS, after reclassification of treasurysecurities, is zero. We are not obligated to fund additional losses of NFS andwill not record future losses of NFS in excess of our net investment. In theprior year, during the period from the date of the Merger to December 31, 2004,we recorded a loss attributable to our equity ownership of NFS in the amount of$1,964,103. Also, in the prior year, during the period from the date of theMerger to December 31, 2004, the issuance of equity securities by NFS at aprice below our book value per share resulted in a recorded loss of $1,893,176.During 2005 the issuance of equity securities by NFS at a price above our bookvalue per share would have resulted in a gain. However, we recognize gains onlyto the extent of previous losses during the period being reported andaccordingly, no net gain was reported in 2005. All of the gains and lossesattributable to NFS are non-cash transactions to us.

 

We received net cash distributions from our Ecuador property of $605,278during 2005, compared to net cash distributions of $190,621 during 2004, whichincluded only six months from the acquisition of the property in June 2004. Ournet interest in the property also increased from 6% to 10% in June 2005. Sinceour investment consists of an interest in a producing oil and gas property, weare amortizing the investment on a straight-line basis over the remaining termof the license agreement covering the property. Accordingly, we recorded $136,552of amortization expense during 2005, compared to $42,760 during the six monthswe owned the property during 2004.

 

We incurred interest expense of $11,149 and amortization of deferred financingcosts of $67,561 in 2005, principally from notes payable incurred to financethe acquisition of SMC in June 2004. In the prior year we incurredinterest expense of $66,959 related to the notes payable incurred to financethe acquisition of SMC in June 2004 and other borrowings, as well asamortization of deferred financing costs of $360,439 primarily from notespayable incurred to finance the acquisition of SMC in June 2004.

 

As a result of our increased cash balance from the private placement ofcommon stock, we received interest income of $509,808 during the year ended December 31,2005. However, as a result of a delay in obtaining an effective Registration Statement we are liableto the investors for liquidated damages in an amount equal to 1.0% of the purchaseprice of the shares for each thirty day period until the Registration Statementis declared effective by the SEC. Accordingly, the Company recorded$515,967 of registration delay expense during the year ended December 31, 2005.

 

We realized anet loss of $8,563,848, or $0.24 per share, for the year ended December 31,2005, compared to a net loss of $10,652,671, or $1.24 per share for the sameperiod in 2004.

 

**Planof Operation**

 

Our current plan of operation is focused primarily on exploiting theresource opportunities in the offshore Block Z-1 in northwest Peru, inwhich we own a 100% working interest. Our initial project is the development ofan integrated gas-to-power project which is more fully described below. Thecapital budget for our plan totals approximately $112.5 million. Toachieve our

 

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objectives, we must obtainsignificant financing from external sources. We are attempting to securefinancing for the project, but we do not have firm commitments from externalsources to allow us to undertake all of the operations envisioned in this plan. See “Liquidity, Capital Resources and CapitalExpenditures,” below, for further discussion.

 

***CorvinaField***

 

Our first priority is drilling the initial gas wells in the CorvinaField to develop reserves and establish gas deliverability at expected levels. InDecember 2005, we signed a drilling contract with Petrex S.A., asubsidiary of Saipem SpA of Italy. Under the contract, Petrex S.A. will providea platform rig capable of drilling to 16,000 feet and upgrade the rig to meetour specifications. We agreed to pay a $5.5 million fee to mobilize and upgradethe rig. In exchange, we will receive a competitive fixed day rate andexclusive rights to use the rig, at our option, during the two-year periodcommencing with delivery of the rig which is expected in June 2006.

 

The Corvina Field has an existing platform which we believe can berefurbished to make it suitable for drilling operations. We have hired acontractor to refurbish the platform and work on this project is ongoing. Ourinitial plans call for the drilling of three new wells from the existingplatform. There is also a shut-in gas well which we intend to recomplete andutilize for gas production. We expect that successful results of these wellswill permit us to disclose proved reserves, provided that we also havesufficient capital resources to be reasonably assured that such reserves can bedeveloped by us. We are working to obtain the required environmental anddrilling permits and complete the platform refurbishment in order to commencedrilling operations in June 2006. Further development drilling from theexisting platform, encompassing three additional wells, is expected to befunded from project cash flows after the power plant is operational.

 

Our plan of operation envisions the installation of a company-owned 160megawatt (“MW”) gas-fired electric generation plant near the town of CaletaCruz, in northwest Peru. In August 2005 we awarded the turnkey contractfor the engineering, procurement and construction (EPC) of the power plantproject to BTEC Turbines LP of Houston (“BTEC”). The contract was awardedfollowing a comprehensive six-month bidding process that included field visitsby all of the bidders. Under the EPC contract, the final terms of which arebeing negotiated, BTEC is expected to supply two General Electric Frame 7simple-cycle gas-fired turbines. BTEC will also act as the main contractor forthe design, transportation, construction, startup and commissioning of thepower plant. Our plan is to own 100% of the power plant. Accordingly, ourrevenues from the natural gas delivered to the power plant will be derived fromthe sale of electricity.

 

We intend to construct a 10-mile offshore pipeline to transport naturalgas from the Corvina Field to the power plant site at Caleta Cruz. The powerplant site has an existing substation and power transmission lines which, withcertain upgrades, are expected to be capable of handling up to 300 MW of power.In order to support our proposed electric generation project, we recentlycommissioned an independent power market analysis for the region. The Peruvianelectricity market is deregulated and power is transported through aninterconnected national grid managed by the Committee for Economic Dispatchingof Electricity (known as “COES”). Based on this study, we believe that we willbe able to sell economic quantities of electricity from our initial 160 MWpower plant at Caleta Cruz. We believe there may be an opportunity in thefuture to generate and profitably sell significantly greater volumes of powerinto the Peruvian and Ecuadorian power markets.

 

Primarily as a result of delays in obtaining a drilling rig, theprojected goal for first sales of power to the Peruvian powermarket is nowlate 2006 or early 2007. This timeline is subject to many factors, includingsecuring necessary financing commitments, which are beyond our control. Basedon the revised timeline, we intend to focus our capital expenditures oncritical drilling activities. Procurement activities on other phases of theproject will be delayed or rescheduled accordingly. We believe that we havesufficient capital resources to fund our initial drilling program. See “Liquidity, Capital Resources and CapitalExpenditures” below for further discussion.

 

In addition to the local power market targeted by our project in Peru,we intend to simultaneously develop a gas sales strategy in nearby Ecuador tocapitalize on what we believe to be significant upside gas potential of theCorvina and Piedra Redonda Fields located in Block Z-1, as well as thepotentially significant natural gas resources in the adjacent onshore Block XIX.These properties are within 30 miles of the Ecuadorian border and can be developedfor export sales of either raw gas or power generation via connection to thetransmission system of Ecuador. Our initial plan of operation calls for us toconstruct a 40-mile pipeline from Caleta Cruz, the terminal point of ouroffshore pipeline from the Corvina Field, to Arenillas, Ecuador. We intend tosell gas for the generation of electricity by third party power producers inthe local market in Ecuador. We have negotiated three preliminary agreementsfor sales of gas. We are planning to complete this pipeline for first sales ofgas to Ecuador during the first half of 2007, though this schedule issubject to many factors outside our control and no assurance can be given thatwe can meet this schedule.

 

***AlbacoraOil Field Redevelopment***

 

In addition to the Corvina Field project, we have initiated theredevelopment of the Albacora oil field located offshore in the northern partof Block Z-1. The field has three shut-in oil wells and a drilling andproduction platform in place which we believe can be refurbished to make itsuitable for drilling operations and is less than 100 miles away from theTalara refinery. We believe this oil field has significant upside potential forsuccessful redevelopment and additional exploration. Our independent

 

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reserve engineers are currently conducting a review of the Albacora oilfield’s crude oil resources and we have initiated efforts to refurbish thedrilling and production platform.

 

***OtherProjects***

 

In addition to the Corvina and Albacora projects, we have other fieldswithin Block Z-1 and Block XIX, which we intend to exploit in the future. Wehave secured the environmental permits and other authorizations to shootseismic in Block Z-1 and Block XIX. We recently completed a technicalevaluation of Area VI and have initiated negotiations to obtain a licensecontract for exploration activities in that area. Area VI is a large onshoreblock in northwest Peru which encompasses the entire Lancones Basin. Based on theresults of our technical evaluation of Area XVI, we have informed Perupetro of our decision not topursue a license contract for that area. We intend to obtain additional fundingfor these projects from industry or capital market sources, but we are notcurrently planning to make significant capital expenditures for seismicacquisition or other exploration and development activities until we havesecured such additional financing.

 

**CapitalExpenditures**

 

We are currently developing engineering plans and designs for thevarious components of our initial plan of operation in the Corvina Field. Wehave obtained cost estimates for most of the major equipment components and theshipping, construction, installation and associated services. However, thecosts of these procurement and construction activities can be difficult toaccurately predict and are subject to change and contingencies. Based on ourcurrent estimates, we expect that our initial project, including the cost ofthe natural gas pipeline to Arenillas, Ecuador, will require total capitalexpenditures on the order of $112.5 million, including import duties andcontingencies. Our budget has increased as a result of higher projecteddrilling costs and the selection of larger capacity turbines. This estimate ofcapital expenditures does not include value added tax (referred to as “IGV” inPeru). IGV is generally imposed on goods and services at a rate of 19%. Certainexpenditures are exempt from IGV or eligible for immediate refund. IGV paid oncapital expenditures is generally recoverable from our future revenue billingswithin Peru and is not considered part of the capitalized costs of theequipment to which it relates. We may also be able to defer payment of certainof these expenditures or obtain separate financing for the IGV.

 

**Project Capital Budget**

 
| ** **                          | ** ** | **($ millions)** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| Power plant and related equipment   |       | 49.6                  |       |
| Pipelines and processing facilities |       | 29.1                  |       |
| Platform and wells                  |       | 23.8                  |       |
| Contingencies                       |       | 10.0                  |       |
| Total estimated capital budget      |       | 112.5                 |       |

 

**Liquidityand Capital Resources**

 

Our initial project for the Corvina Field in offshoreBlock Z-1 located in northwest Peru, totaling approximately $112.5million, includes the refurbishment of the CX-11 platform,rehabilitation of an existing well and the drilling of three new wells,installation of a 10-mile gas pipeline from the platform to shore, constructionof a 160 MW simple-cycle electric generating plant, and the construction of a40-mile gas pipeline to supply gas to third party generators in Arenillas, Ecuador.

 

In connection with the Merger, we receivednet proceeds of approximately $5.5 million from a private placement of ourcommon stock. In July 2005, we completed a private placement of 11,466,000shares of common stock for net proceeds of approximately $31.9 million. MorganKeegan & Company, Inc. served as placement agent for the offering.We also received $3.9 million from the exercise of warrants during 2005. Asof December 31, 2005, our cash balance was approximately $29.5 million.

 

In January 2005, we deposited$1.3 million as restricted cash to secure our performance obligationsunder the second exploration period of the Block Z-1 license contract. Weintend to satisfy this obligation by drilling a well, which is currentlyexpected to cost approximately $5.0 million and is included in the capitalbudget for the project. During the year ended December 31, 2005, weincurred capital expenditures of approximately $4.4 million, primarily onrefurbishment of the Corvina platform and power plant design costs. Inaddition, we have committed to pay $5.5 million in early 2006 to mobilize andupgrade a platform drilling rig for use in the Corvina Field and potentiallyfor our other projects.

 

In May 2005, we signed a Mandate Letterwith the International Finance Corporation (“IFC”), a member of the World BankGroup based in Washington, D.C. The Mandate Letter specifies that the IFC willappraise our project in Peru to determine the feasibility and structure ofpotential financing for the project. The IFC’s appraisal of the project willinclude a review of the technical, economic, commercial, financial,environmental and legal aspects of the project. IFC’s financing, the structureof which would be defined during the appraisal process, will depend on theproject and the Company meeting the IFC’s financing criteria, the overallfinancing plan being acceptable to IFC, approval of the investment bymanagement and the Board of IFC, and the execution of all appropriatedocumentation, in form and substance satisfactory to IFC. As part of theMandate, we have agreed to pay fees of $285,000 and customary expenses duringthe appraisal period. The IFC is continuing its due diligence on the project.

 

22

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In recognition of the revised drilling timeline, the IFC recentlyextended the Mandate period through August 2006 and is reviewing aproposed increase in the total amount of the financing based on the increasedcapital budget for the project.

 

With our current cash balance and proceeds from the expected IFCfinancing, we believe we will have sufficient capital resources to execute theproject as currently planned. However, the timing and executionof our project is dependent on a variety of factors, including technical designof facilities, permitting, availability of equipment, time and costs requiredfor delivery and construction, performance by contractors and financing, manyof which are outside our control.

 

**Off-BalanceSheet Arrangements**

 

As of December 31, 2005, we had no transactions, agreements orother contractual arrangements with unconsolidated entities or financialpartnerships, often referred to as special purpose entities, which generallyare established for the purpose of facilitating off-balance sheet arrangements.

 

**CriticalAccounting Policies and Recent Accounting Pronouncements**

 

The discussion and analysis of our financial condition and results ofoperations is based on our consolidated financial statements, which have beenprepared in accordance with U.S. generally accepted accounting principles (“GAAP”).Management uses estimates and assumptions in preparing the consolidatedfinancial statements in accordance with GAAP. Those estimates and assumptionsaffect the reported amounts of assets, liabilities, revenues and expenses inthe consolidated financial statements, and the disclosure of contingent assetsand liabilities. We have identified the following as critical accountingpolicies directly related to our business and operations, and the understandingof our financial statements.

 

***SuccessfulEfforts Method of Accounting***

 

We follow the successful efforts method of accounting for ourinvestments in oil and gas properties. Under this method, oil and gas leaseacquisition costs and intangible drilling costs associated with explorationefforts that result in the discovery of proved reserves and costs associatedwith development drilling, whether or not successful, are capitalized whenincurred. Certain costs of exploratory wells are capitalized pendingdeterminations that proved reserves have been found. If the determination isdependent upon the results of planned additional wells and required capitalexpenditures to produce the reserves found, the drilling costs will becapitalized as long as sufficient reserves have been found to justifycompletion of the exploratory well and additional wells are underway or firmlyplanned to complete the evaluation of the exploratory well. All costs relatedto unsuccessful exploratory wells are expensed when such wells are determinedto be non-productive or at the one year anniversary of completion of the wellif proved reserves have not been attributed and capital expenditures asdescribed in the preceding sentence are not required. We assess our capitalizedexploratory wells pending evaluation each quarter to determine whether costsshould remain capitalized or should be charged to earnings. Other explorationcosts, including geological and geophysical costs, are expensed as incurred. Wewill recognize gains or losses on the sale of properties, should they occur, ona field-by-field basis.

 

The application of the successful efforts method of accounting requiresmanagement’s judgment to determine the proper designation of wells as eitherdevelopmental or exploratory, which will ultimately determine the properaccounting treatment of the costs incurred. The results from a drillingoperation can take considerable time to analyze, and the determination thatcommercial reserves have been discovered requires both judgment and applicationof industry experience. Wells may be completed that are assumed to beproductive and actually deliver oil and gas in quantities insufficient to beeconomic, which may result in the abandonment of the wells at a later date. Theevaluations of oil and gas leasehold acquisition costs requires management’sjudgment to estimate the fair value of exploratory costs related to drillingactivity in a given area.

 

The successful efforts method of accounting can have a significantimpact on the operational results reported when we enter a new exploratory areain hopes of finding oil and gas reserves. Seismic costs can be substantialwhich will result in additional exploration expenses when incurred. The initialexploratory wells may be unsuccessful and the associated costs will then beexpensed as dry hole costs and any associated leasehold costs may be impaired.

 

***Impairmentof Long-Lived Assets***

 

We periodically evaluate the recoverability of the carrying value ofour long-lived assets and identifiable intangibles by monitoring and evaluatingchanges in circumstances that may indicate that the carrying amount of theasset may not be recoverable. Examples of events or changes in circumstancesthat indicate that the recoverability of the carrying amount of an asset shouldbe assessed include but are not limited to (a) a significant decrease inthe market value of an asset, (b) a significant change in the extent ormatter in which an asset is used or a significant physical change in an asset,(c) a significant adverse change in legal factors or in the businessclimate that could affect the value of an asset or an adverse action orassessment by a regulator, (d) an accumulation of costs significantly inexcess of the amount originally expected to acquire or construct an asset,and/or (e) a current period operating or cash flow loss combined with ahistory of operating or cash flow losses or a projection or forecast thatdemonstrates continuing losses associated with an asset used for the purpose ofproducing revenue.

 

We consider historical performance and anticipated future results inour evaluation of potential impairment. Accordingly, when indicators ofimpairment are present, we evaluate the carrying value of these assets inrelation to the operating performance

 

23

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of the business and future discounted and non-discounted cash flowsexpected to result from the use of these assets. Impairment losses arerecognized when the expected future cash flows from an asset are less than itscarrying value.

 

***FutureDismantlement, Restoration, and Abandonment Costs***

 

The accounting for future development and abandonment costs changed onJanuary 1, 2003, with the issuance of Statement of Financial AccountingStandards (“SFAS”) No. 143 “Accounting for Asset Retirement Obligation” (“ARO”),which requires that the fair value of a liability for an asset retirementobligation to be recognized in the period in which it is incurred if areasonable estimate of fair value can be made. The associated asset retirementcosts are capitalized as part of the carrying amount of the long-lived asset. Theaccrual is based on estimates of these costs for each of our properties basedupon the type of production structure, reservoir characteristics, depth of thereservoir, market demand for equipment, currently available procedures andconsultations with construction and engineering consultants. Because thesecosts typically extend many years into the future, estimating these costs isdifficult and requires management to make estimates and judgments that aresubject to future revisions based on numerous factors, including changingtechnology, the political and regulatory environment and estimates as to theproper discount rate to use and timing of abandonment.

 

Our plan of operations includes the drilling of wells and theconstruction of an electric power generation plant. We will be required to plugand abandon those wells and restore the well sites and power generation siteupon abandonment if they are abandoned prior to the end of the contract period.However, due to the fact that we have not yet begun operations, we do not havesufficient information to determine the timing, nor calculate the presentvalue, of the obligation. Therefore, no such provision is reflected in theaccompanying consolidated financial statements.

 

***StockBased Compensation***

 

As permitted under SFAS No. 123, “Accounting for Stock-BasedCompensation,” we follow the provisions of Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under APB25, compensation expense is recorded for stock options granted to employees anddirectors only if the current market price of the underlying stock exceeds theexercise price. Transactions in equity instruments with non-employees for goodsor services are accounted for under the fair value method. For periodsbeginning after December 15, 2005, we will be required to account for alltransactions which result in the exchange of equity instruments for goods andservices, including stock options granted to employees and directors, underSFAS 123(R), “Share-Based Payment.” SFAS 123(R) requires that all such transactions be measured at fairvalue and recorded as an expense over the service period.

 

None of the equity instruments that we issued in exchange for goods andservices during the periods covered by this report were eligible for treatmentunder the intrinsic value method in APB 25 and all of such issuances gave riseto stock-based compensation expense based on the fair value of the instrumentsat the date of grant or issuance. Accordingly, our results of operations forthe periods presented would not have been affected had we been subject to theprovisions SFAS 123(R) for such periods.

 

***AccountingChanges and Error Corrections***

 

In June 2005,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 154, Accounting Changes and Error Corrections (“SFAS154”), which replaced Accounting Principles Board Opinion No. 20,Accounting Changes (“APB 20”), and Statement of Financial Accounting StandardsNo. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS154 requires retrospective application to prior period financial statements ofa voluntary change in accounting principle unless it is impracticable. Incontrast, APB 20 previously required that most voluntary changes in accountingprinciple be recognized by including the cumulative effect of changing to thenew accounting principle in net income in the period of change. SFAS 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. Earlier application is permitted foraccounting changes and correction of errors made in fiscal years beginningafter June 1, 2005. SFAS 154 does not change the transition provisions ofany existing accounting pronouncements, including those that are in atransition phase as of its effective date. We have elected to adopt theprovisions of SFAS 154 on January 1, 2006. We do not expect adoption tohave a material effect on our results of operations or financial position.

 

***Principles ofConsolidation***

 

Our consolidated financial statements include the accounts of theCompany and its wholly owned subsidiaries and branch offices.  Allintercompany balances and transactions have been eliminated.  However, as discussed in Note 6 to theConsolidated Financial Statements, we account for our nominal ownership inNavidec Financial Services, Inc. (“NFS”) under the equity method.  Pursuant to the Merger Agreement, we are contractuallybound to spin-off NFS to the pre-merger shareholders of Navidec.  Pending the final distribution of NFS sharesin the spin-off, we are the nominal owner of a majority of the common shares ofNFS, but we do not control NFS.  As of December31, 2005, our net investment in NFS is zero. We are not obligatedto fund additional losses of NFS and will not record future losses of NFS inexcess of our net investment.

 

Ouraccounting policy regarding partnership or joint venture interests in oil andgas properties is to

 

24

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consolidate suchinterests on a pro-rata basis in accordance with accepted practice in the oiland gas industry.  However, we have notbeen able to receive timely information to allow us to proportionatelyconsolidate the minority non-operated working interest owned by our consolidatedsubsidiary, SMC Ecuador Inc.  See Note 5to the Consolidated Financial Statements for further discussion regarding the investmentin our Ecuador property.  Accordingly, weaccount for this investment under the cost method.  As such, we record our share of cash receivedor paid attributable to this investment as other income or expense.

 

***Foreign Exchange***

 

The U.S. Dollar is the functional currency for our operations in bothPeru and Ecuador. Ecuador has adopted the U.S. Dollar as its official currency.Peru, however, still uses its local currency, Nuevo Soles, in addition to theU.S. Dollar and therefore our financial results are subject to favorable orunfavorable fluctuations in the exchange rate and inflation of that country. Wehave adopted SFAS No. 52, “Foreign Currency Translation,” which requiresthat the translation of the applicable foreign currency into U.S. dollars beperformed for balance sheet monetary accounts using current exchange rates ineffect at the balance sheet date, non-monetary accounts using historicalexchange rates in effect at the time the transaction occurs, and for revenueand expense accounts using a weighted average exchange rate during the periodreported. Accordingly, the gains or losses resulting from such translation areincluded in other income and expense in the consolidated statements ofoperations. Due to the relatively low level of activity to-date and therelatively steady exchange rate in Peru, translation differences, if any, wereimmaterial.

 

25

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**Item 7.****                                  ****Financial Statements**

 

BPZ Energy, Inc. and Subsidiaries

Index to Consolidated Financial Statements

 
| Report of Independent  Registered Public Accounting Firm                                                                                                             |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                 |   |
| Consolidated Balance Sheets as of  December 31, 2005 and 2004                                                                                                   |   |
|                                                                                                                                                                 |   |
| Consolidated Statements of  Operations for the Years Ended December 31, 2005 and 2004 and for the  period from August 20, 2001 (Inception) to December 31, 2005 |   |
|                                                                                                                                                                 |   |
| Consolidated Statements of  Stockholders’ Equity (Deficit) for the Years Ended December 31, 2005 and  2004                                                 |   |
|                                                                                                                                                                 |   |
| Consolidated Statements of  Cash Flows for the Years Ended December 30, 2005 and 2004 and for the  period from August 20, 2001 (Inception) to December 31, 2005 |   |
|                                                                                                                                                                 |   |
| Notes to Consolidated  Financial Statements                                                                                                                          |   |

 

26

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**Report of Independent Registered Public Accounting Firm**

 

To the Board of Directors

BPZ Energy, Inc. and Subsidiaries

(A Development Stage Company)

 

We have audited the consolidated balance sheets of BPZ Energy, Inc. and Subsidiaries (A Development Stage Company), as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for each of the years then ended and for the period from August 20, 2001 (date of inception) through December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free from material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BPZ Energy, Inc. and Subsidiaries (A Development Stage Company) as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the years then ended and for the period from August 20, 2001 (date of inception) through December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

 

 
| */s/ Johnson Miller & Co., CPA’s PC* |   |
|-----------------------------------------------|--------|
| Johnson Miller & Co., CPA’s PC       |
|                                          |
|                                          |
| Midland, Texas                                |
| March 30, 2006                                |

 

27

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**BPZ Energy, Inc. and Subsidiaries**

**(A Development Stage Company)**

**ConsolidatedBalance Sheets**

**As ofDecember 31, 2005 and 2004**

 
| ** **                                                         | ** ** | **2005**    | ** ** | **2004**    | ** ** |
|--------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **ASSETS**                                                         |       |        |       |        |       |
|                                                               |       |        |       |        |       |
| Current assets:                                                    |       |        |       |        |       |
| Cash and cash equivalents                                          |       | $           | 29,455,130 |        | $          | 4,014,191 |   |
| Restricted cash                                                    |       | —      |       | 100,000     |       |
| Other                                                              |       | 869,669     |       | 72,159      |       |
| Total current assets                                               |       | 30,324,799  |       | 4,186,350   |       |
|                                                               |       |        |       |        |       |
| Property, equipment and construction in  progress, net             |       | 4,365,040   |       | 5,505       |       |
| Restricted cash                                                    |       | 1,455,953   |       | —      |       |
| Investment in Ecuador property, net                                |       | 1,945,188   |       | 969,240     |       |
| Investment in Navidec Financial Services                           |       | —      |       | 1,130,511   |       |
|                                                               |       |        |       |        |       |
| Total assets                                                       |       | $           | 38,090,980 |        | $          | 6,291,606 |   |
|                                                               |       |        |       |        |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                     |       |        |       |        |       |
|                                                               |       |        |       |        |       |
| Current  liabilities:                                              |       |        |       |        |       |
| Accounts payable                                                   |       | $           | 747,347    |        | $          | 311,613 |   |
| Accrued liabilities                                                |       | 470,632     |       | 54,342      |       |
| Other liabilities                                                  |       | 70,516      |       | —      |       |
| Note payable                                                       |       | —      |       | 208,986     |       |
|                                                               |       |        |       |        |       |
| Total current liabilities                                          |       | 1,288,495   |       | 574,941     |       |
|                                                               |       |        |       |        |       |
| Long-term debt                                                     |       | 70,908      |       | —      |       |
|                                                               |       |        |       |        |       |
| Stockholders’ equity:                                         |       |        |       |        |       |
| Preferred stock, no par value, 25,000,000  authorized, none issued |       | —      |       | —      |       |
| Common stock, no par value, 250,000,000  authorized                |       | 60,633,684  |       | 17,478,446  |       |
| Additional paid in capital — warrants and  stock options      |       | 2,362,283   |       | 2,341,795   |       |
| Deferred stock-based compensation                                  |       | (3,992,172  | )          | —      |       |
| Common stock and warrants held by affiliate                        |       | (2,458,975  | )          | (2,854,181  | )          |
| Stock subscription receivable                                      |       | (230,825    | )          | (230,825    | )          |
| Deficit accumulated during the development  stage                  |       | (19,582,418 | )          | (11,018,570 | )          |
|                                                               |       |        |       |        |       |
| Total stockholders’ equity                                    |       | 36,731,577  |       | 5,716,665   |       |
|                                                               |       |        |       |        |       |
| Total liabilities and stockholders’ equity                    |       | $           | 38,090,980 |        | $          | 6,291,606 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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**BPZ Energy, Inc. and Subsidiaries**

**(A Development Stage Company)**

**Consolidated Statements of Operations**

**Years ended December 31, 2005 and 2004**

 
| ** **                                               | ** ** | **Cumulative  Amounts from  August 20, 2001  (Inception) to  December 31, 2005** | ** **  | **2005**   | ** ** | **2004**    | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------------------------------------------------|-------------|------------|------------|-------------|------------|
|                                                     |       |                                                                                  |        |       |       |        |       |
| Revenue                                                  |       | $                                                                                     | —      |       | $          | —      |       | $ | — |   |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Operating  and administrative expenses:                  |       |                                                                                  |        |       |       |        |       |
| General and administrative                               |       | 6,548,180                                                                             |        | 4,422,747  |       | 1,752,927   |       |
| Stock-based compensation                                 |       | 5,797,414                                                                             |        | 1,382,479  |       | 4,414,935   |       |
| Geological, geophysical and engineering                  |       | 1,359,096                                                                             |        | 998,131    |       | 360,965     |       |
| Depreciation expense                                     |       | 29,795                                                                                |        | 29,638     |       | 157         |       |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Total operating expenses                                 |       | 13,734,485                                                                            |        | 6,832,995  |       | 6,528,984   |       |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Operating loss                                           |       | (13,734,485                                                                           | )           | (6,832,995 | )          | (6,528,984  | )          |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Other income (expense):                                  |       |                                                                                  |        |       |       |        |       |
| Investment income from SMC Ecuador, net of  amortization |       | 616,587                                                                               |        | 468,726    |       | 147,861     |       |
| Equity in loss of NFS                                    |       | (4,120,962                                                                            | )           | (2,156,859 | )          | (1,964,103  | )          |
| Loss on issuance of equity securities by  NFS            |       | (1,893,176                                                                            | )           | —     |       | (1,893,176  | )          |
| Interest expense                                         |       | (78,108                                                                               | )           | (11,149    | )          | (66,959     | )          |
| Amortization of deferred financing costs                 |       | (428,000                                                                              | )           | (67,561    | )          | (360,439    | )          |
| Registration delay expense                               |       | (515,967                                                                              | )           | (515,967   | )          | —      |       |
| Interest income                                          |       | 509,808                                                                               |        | 509,808    |       | —      |       |
| Miscellaneous income                                     |       | 61,885                                                                                |        | 42,149     |       | 13,129      |       |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Total other income (expense)                             |       | (5,847,933                                                                            | )           | (1,730,853 | )          | (4,123,687  | )          |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Loss before income taxes                                 |       | (19,582,418                                                                           | )           | (8,563,848 | )          | (10,652,671 | )          |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Income taxes                                             |       | —                                                                                |        | —     |       | —      |       |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Net loss                                                 |       | $                                                                                     | (19,582,418 | )          | $          | (8,563,848  | )          | $ | (10,652,671 | ) |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Basic and diluted net loss per share                     |       |                                                                                  |        | $          | (0.24      | )           | $          | (1.24 | ) |
|                                                     |       |                                                                                  |        |       |       |        |       |
| Weighted average common shares outstanding               |       |                                                                                  |        | 36,078,760 |       | 8,558,525   |       |
|                                                          |            |                                                                                       |             |            |            |             |            |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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** **

**BPZEnergy, Inc. and Subsidiaries**

**(ADevelopment Stage Company)**

# **Consolidated Statements ofStockholders’ Equity (Deficit)**

**Years EndedDecember 31, 2005 and 2004**

 
| ** **                                                  | ** ** | **Common  Stock Issued** | ** ** | **Additional  Paid-in** | ** ** | **Deferred  Stock-based** | ** ** | **Common  Stock and  Warrants  Held by** | ** ** | **Stock  Subscription** | ** ** | **Deficit  Accumulated  During the  Development** | ** ** | ** **  | ** ** |
|-------------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|---------------------------|------------|------------------------------------------|------------|-------------------------|------------|---------------------------------------------------|------------|-------------|------------|
| ** **                                                  | ** ** | **Shares**               | ** ** | **Amount**              | ** ** | **Capital**               | ** ** | **Compensation**                         | ** ** | **Affiliate**           | ** ** | **Receivable**                                    | ** ** | **Stage**   | ** ** | **Total** | ** ** |
|                                                        |       |                     |       |                    |       |                      |       |                                     |       |                    |       |                                              |       |        |       |   |   |
| Balance, December  31, 2003                                 |       | 4,103,454                |       | $                       | 1,000      |                      | $          | —                                   |       | $                       | —     |                                              | $          | —      |       | $ | — |   | $ | (365,899 | ) | $ | (364,899 | ) |
|                                                        |       |                     |       |                    |       |                      |       |                                     |       |                    |       |                                              |       |        |       |   |   |
| Common stock  issued for services                           |       | 2,857,642                |       | 3,714,935               |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 3,714,935 |   |
| Stock-based  compensation                                   |       | —                   |       | —                  |       | 700,000                   |       | —                                   |       | —                  |       | —                                            |       | —      |       | 700,000 |   |
| Common stock  issued in acquisition                         |       | 3,860,517                |       | 5,713,565               |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 5,713,565 |   |
| Warrant and stock  options issued or assumed in acquisition |       | —                   |       | —                  |       | 1,785,359                 |       | —                                   |       | —                  |       | —                                            |       | —      |       | 1,785,359 |   |
| Conversion of  long-term debt to common stock               |       | 1,802,376                |       | 685,000                 |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 685,000 |   |
| Common stock  issued for cash and future consideration      |       | 236,528                  |       | 350,000                 |       | —                    |       | —                                   |       | —                  |       | (230,825                                          | )          | —      |       | 119,175 |   |
| Exercise of stock  options assumed in acquisition           |       | 220,868                  |       | 486,610                 |       | (143,564                  | )          | —                                   |       | —                  |       | —                                            |       | —      |       | 343,046 |   |
| Common stock sold  for cash, net of offering costs          |       | 3,000,000                |       | 5,506,807               |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 5,506,807 |   |
| Conversion of  note payable to common stock                 |       | 500,000                  |       | 1,020,529               |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 1,020,529 |   |
| Common stock and  warrants held by affiliate                |       | —                   |       | —                  |       | —                    |       | —                                   |       | (2,854,181              | )          | —                                            |       | —      |       | (2,854,181 | ) |
| Net loss                                                    |       | —                   |       | —                  |       | —                    |       | —                                   |       | —                  |       | —                                            |       | (10,652,671 | )          | (10,652,671 | ) |
|                                                        |       |                     |       |                    |       |                      |       |                                     |       |                    |       |                                              |       |        |       |   |   |
| Balance, December  31, 2004                                 |       | 16,581,385               |       | 17,478,446              |       | 2,341,795                 |       | —                                   |       | (2,854,181              | )          | (230,825                                          | )          | (11,018,570 | )          | 5,716,665 |   |
|                                                        |       |                     |       |                    |       |                      |       |                                     |       |                    |       |                                              |       |        |       |   |   |
| Stock-based  compensation                                   |       | 35,000                   |       | 146,650                 |       | 300,000                   |       | —                                   |       | —                  |       | —                                            |       | —      |       | 446,650 |   |
| Exercise of stock  options assumed in acquisition           |       | 401,389                  |       | 892,045                 |       | (260,903                  | )          | —                                   |       | —                  |       | —                                            |       | —      |       | 631,142 |   |
| Exercise of  warrants                                       |       | 1,403,500                |       | 4,211,870               |       | (343,609                  | )          | —                                   |       | —                  |       | —                                            |       | —      |       | 3,868,261 |   |
| Restricted stock  awards                                    |       | 1,120,000                |       | 4,928,000               |       | —                    |       | (3,992,172                               | )          | —                  |       | —                                            |       | —      |       | 935,828 |   |
| Common stock  issued to acquire property interest           |       | 250,000                  |       | 1,112,500               |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 1,112,500 |   |
| Common stock sold  for cash, net of offering costs          |       | 11,466,000               |       | 31,917,213              |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 31,917,213 |   |
| Warrants issued  in connection with sale of common stock    |       | —                   |       | (325,000                | )          | 325,000                   |       | —                                   |       | —                  |       | —                                            |       | —      |       | — |   |
| Common stock  issued pursuant to merger earn-out agreement  |       | 9,000,000                |       | —                  |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | — |   |
| Net change in  common stock and warrants held by affiliate  |       | —                   |       | —                  |       | —                    |       | —                                   |       | 395,206                 |       | —                                            |       | —      |       | 395,206 |   |
| Common stock  issued for registration delay expenses        |       | 92,705                   |       | 271,960                 |       | —                    |       | —                                   |       | —                  |       | —                                            |       | —      |       | 271,960 |   |
| Net loss                                                    |       | —                   |       | —                  |       | —                    |       | —                                   |       | —                  |       | —                                            |       | (8,563,848  | )          | (8,563,848 | ) |
|                                                        |       |                     |       |                    |       |                      |       |                                     |       |                    |       |                                              |       |        |       |   |   |
| Balances at  December 31, 2005                              |       | 40,349,979               |       | $                       | 60,633,684 |                      | $          | 2,362,283                                |       | $                       | (3,992,172 | )                                                 | $          | (2,458,975  | )          | $ | (230,825 | ) | $ | (19,582,418 | ) | $ | 36,731,577 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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** **

**BPZ Energy, Inc. and Subsidiaries**

**(A Development Stage Company)**

**ConsolidatedStatements of Cash Flows**

**Years ended December 31, 2005and 2004**

 
| ** **                                                                   | ** ** | **Cumulative  Amounts from  Inception to** | ** **  | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------|-------------|------------|------------|------------|------------|
| ** **                                                                   | ** ** | **December 31, 2005**                 | ** **  | **2005**   | ** ** | **2004**   | ** ** |
| ** **                                                                   | ** ** | ** **                                 | ** **  | ** ** | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                        |       |                                       |        |       |       |       |       |
| Net loss                                                                     |       | $                                          | (19,582,418 | )          | $          | (8,563,848 | )          | $ | (10,652,671 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                                       |        |       |       |       |       |
| Stock-based compensation                                                     |       | 5,797,414                                  |        | 1,382,479  |       | 4,414,935  |       |
| Stock issued for registration delay  expenses                                |       | 271,960                                    |        | 271,960    |       | —     |       |
| Depreciation expense                                                         |       | 29,795                                     |        | 29,638     |       | 157        |       |
| Amortization of investment in SMC Ecuador                                    |       | 179,312                                    |        | 136,552    |       | 42,760     |       |
| Amortization of deferred financing fees                                      |       | 428,000                                    |        | 67,561     |       | 360,439    |       |
| Equity in loss of Navidec Financial  Services                                |       | 4,120,962                                  |        | 2,156,859  |       | 1,964,103  |       |
| Loss on issuance of equity securities by  Navidec Financial Services         |       | 1,893,176                                  |        | —     |       | 1,893,176  |       |
| Changes in operating assets and  liabilities:                                |       |                                       |        |       |       |       |       |
| (Increase) decrease in other assets                                          |       | (869,671                                   | )           | (865,072   | )          | (418       | )          |
| Increase in accounts payable                                                 |       | 747,349                                    |        | 435,736    |       | 301,137    |       |
| Increase in accrued liabilities                                              |       | 452,134                                    |        | 397,792    |       | 39,692     |       |
| Increase in other liabilities                                                |       | 70,517                                     |        | 70,517     |       | —     |       |
| Net cash used by operating activities                                        |       | (6,461,470                                 | )           | (4,479,826 | )          | (1,636,690 | )          |
|                                                                         |       |                                       |        |       |       |       |       |
| Cash flows from investing activities:                                        |       |                                       |        |       |       |       |       |
| Property and equipment additions                                             |       | (4,394,839                                 | )           | (4,389,177 | )          | (5,662     | )          |
| Restricted cash                                                              |       | (1,455,953                                 | )           | (1,355,953 | )          | 140,000    |       |
| Investment in Ecuador property                                               |       | (1,440,000                                 | )           | —     |       | (1,440,000 | )          |
| Net cash used by investing activities                                        |       | (7,290,792                                 | )           | (5,745,130 | )          | (1,305,662 | )          |
|                                                                         |       |                                       |        |       |       |       |       |
| Cash flows from financing activities:                                        |       |                                       |        |       |       |       |       |
| Borrowings                                                                   |       | 2,245,325                                  |        | 115,325    |       | 1,375,000  |       |
| Repayments of borrowings                                                     |       | (450,389                                   | )           | (234,904   | )          | (215,485   | )          |
| Proceeds from exercise of warrants, net                                      |       | 3,868,261                                  |        | 3,868,261  |       | —     |       |
| Proceeds from sale of common stock, net                                      |       | 37,544,195                                 |        | 31,917,213 |       | 5,625,982  |       |
| Advances to affiliates                                                       |       | —                                     |        | —     |       | 162,890    |       |
| Net cash provided by financing activities                                    |       | 43,207,392                                 |        | 35,665,895 |       | 6,948,387  |       |
|                                                                         |       |                                       |        |       |       |       |       |
| Net increase (decrease) in cash and cash  equivalents                        |       | 29,455,130                                 |        | 25,440,939 |       | 4,006,035  |       |
| Cash and cash equivalents at beginning of  period                            |       | —                                     |        | 4,014,191  |       | 8,156      |       |
| Cash and cash equivalents at end of period                                   |       | $                                          | 29,455,130  |       | $          | 29,455,130 |       | $ | 4,014,191 |   |
|                                                                         |       |                                       |        |       |       |       |       |
| Supplemental cash flow information:                                          |       |                                       |        |       |       |       |       |
| **Cash paid for:**                                                           |       |                                       |        |       |       |       |       |
| Interest                                                                     |       | $                                          | 77,704      |       | $          | 13,761     |       | $ | 63,943 |   |
| **Non – cash items:**                                                   |       |                                       |        |       |       |       |       |
| Common stock issued for property interest                                    |       | $                                          | 1,112,500   |       | $          | 1,112,500  |       | $ | — |   |
| Warrants issued to private placement agent                                   |       | 325,000                                    |        | 325,000    |       | —     |       |
| Common stock issued in acquisition                                           |       | 5,713,565                                  |        | —     |       | 5,713,565  |       |
| Warrants and stock options assumed in  acquisition                           |       | 1,785,359                                  |        | —     |       | 1,785,359  |       |
| Common stock and warrants held by affiliate                                  |       | 2,458,975                                  |        | (395,206   | )          | 2,854,181  |       |
| Imputed financing costs                                                      |       | 428,000                                    |        | —     |       | 428,000    |       |
| Proceeds received by NFS from exercise of  stock options                     |       | 974,189                                    |        | 631,143    |       | 343,046    |       |
| Issuance of common stock for subscription  receivable                        |       | 230,825                                    |        | —     |       | 230,825    |       |
| Conversion of long-term debt to common  stock                                |       | 685,000                                    |        | —     |       | 685,000    |       |
| Conversion of notes payable to common stock                                  |       |                                       | 1,020,529   |       | —     |       |       | 1,020,529 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

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**BPZ Energy,Inc and Subsidiaries**

**(ADevelopment Stage Company)**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

 

**December 31, 2005 and 2004**

 

**Note1 – Basis of Presentation and Significant Accounting Policies**

 

**Organization and Basis of Presentation**

 

BPZ Energy, Inc., a Colorado corporation, wasincorporated in 1993. It was formerly named Navidec, Inc. Based in Houston, Texas,weare a development stage company with properties innorthwest Peru and southwest Ecuador. We are focused on thedevelopment and production of oil and natural gas and we intend to utilize partof our future natural gas production for the complementary development ofgas-fired power generation.

 

On September 10, 2004, BPZ Energy, Inc., aTexas corporation (“BPZ-Texas”), consummated a reverse merger with Navidec,Inc. (“Navidec”) whereby BPZ-Texas became a wholly owned subsidiary of Navidec(the “Merger”). However, in the Merger, the stockholder group of BPZ-Texasobtained majority ownership and management control of the combined Company.Accordingly, for accounting purposes, the Merger was treated as a reversemerger of Navidec by BPZ-Texas. All financial statements presented hereinrepresent the historical financial statements of the accounting acquirer,BPZ-Texas. The details of the Merger are discussed in Note 2 to theConsolidated Financial Statements. On February 4, 2005, the legal parentcompany, Navidec, Inc., changed its name to BPZ Energy, Inc. Although theCompany’s name has been changed, the pre-merger company may be referred to asNavidec in this filing to avoid confusion.

 

The Merger required thetransfer of all of the pre-merger business assets and liabilities of Navidec toits wholly owned subsidiary, Navidec Financial Services, Inc. (“NFS”), and thespin-off of NFS to the shareholders of record of Navidec as of September 9,2004, the date prior to the Merger. Upon consummation of the Merger, theCompany became contractually and irrevocably bound to the spin-off of NFS tosuch pre-Merger shareholders. All legal requirements for the spin-off of NFShave been completed except for registration of the spin-off with the Securitiesand Exchange Commission and the final distribution of NFS common shares to thepre-merger shareholders of the Company. Pending such final distribution of NFScommon shares, the Company remains the nominal owner of those shares, which arebeing held for the benefit of the spin-off shareholders. The Company accountsfor its nominal investment in NFS under the equity method, as discussed in Note6 to the Consolidated Financial Statements. As of December 31, 2005, theCompany’s net investment in NFS is zero. As a result, future NFS losses willnot be recorded by the Company. The Company has no control over theregistration process of NFS and cannot predict when the management of NFS willbe able to complete the final distribution of NFS common shares.

 

The Company maintains an officeand a registered branch in Peru. Currently,BPZ has exclusive rights and license agreements for oil and gas exploration andproduction covering a total of approximately 2.7 million acres in northwestPeru. BPZ’slicense contracts cover 100% ownership of both Block Z-1, which was signed inNovember 2001 and Block XIX, which was signed in December2003. Thelicense contractsprovide for an initial exploration period of seven to ten years and require BPZto conduct specified activities on the properties during this period. The totalcontract term can extend up to 30 years for oil developmentand production and 40 years for gas development and production. In December2003, BPZ entered into a Technical Evaluation Agreement for AreaVI. Thisagreement gave the Company the right to conduct a technicalevaluationof the area over a 24-month period and the exclusive right toenter into a license contract if the evaluationindicated the potential for successful operations. In December2005, BPZ initiated negotiations to obtain a license contract for Area VI.

 

The Company also owns a10% non-operated working interest in a producingoil and gas property located in southwest Ecuador (the“SantaElena Property”).The license agreement covering the property extends through May2016.

 

BPZ is in the developmentstage and to date its activities in Peru have been limited to analysis andevaluation of technical data on the properties and preparation of thedevelopment plans for the properties. The Company has not drilled any wells orrecognized any revenues from operations and we do not anticipate generatingsignificant revenues from our properties prior to 2007.

 

**Principles of Consolidation**

 

The consolidated financial statements includethe accounts of the Company and its wholly owned subsidiaries and branchoffices. All intercompany balances and transactions have been eliminated.However, as discussed in Note 6 to the Consolidated FinancialStatements, the Company accounts for its nominal ownership in NFS under theequity method. Pursuant to the Merger Agreement, defined below, the Company iscontractually bound to spin-off NFS to the pre-merger shareholders of Navidec. Pendingthe final distribution of NFS shares in the spin-off, the Company is thenominal owner of a majority of the common shares of NFS, but does not controlNFS. As a result of the cumulative losses by NFS recognized by the Company, as of December31, 2005, the Company’s net investment in NFS is zero. The Company is notobligated to fund additional losses of NFS and will not record future losses ofNFS in excess of its net investment.

 

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The Company’s accounting policy regarding partnership or joint ventureinterests in oil and gas properties is to consolidate such interests on apro-rata basis in accordance with accepted practice in the oil and gas industry.However, the Company has not been able to receive timely information to allowit to proportionately consolidate the minority non-operated working interestowned by its consolidated subsidiary, SMC Ecuador Inc. See Note 5 to theConsolidated Financial Statements for further discussion regarding the Company’sinvestment in its Ecuador property. Accordingly, the Company accounts for thisinvestment under the cost method. As such, the Company records its share ofcash received or paid attributable to this investment as other income orexpense.

 

**Reporting and Functional Currency**

 

The U.S. Dollar is the functional currencyfor our operations in both Peru and Ecuador. Ecuador has adopted the U.S.Dollar as its official currency. Peru, however, uses its local currency, NuevoSoles, in addition to the U.S. Dollar and therefore our financial results aresubject to foreign currency gains and losses. We have adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 52, “Foreign CurrencyTranslation”, which requires that the translation of the applicable foreigncurrency into U.S. dollars be performed for balance sheet monetary accountsusing current exchange rates in effect at the balance sheet date, non-monetaryaccounts using historical exchange rates in effect at the time the transactionoccurs, and for revenue and expense accounts using a weighted average exchangerate during the period reported. Accordingly, the gains or losses resultingfrom such translation are included in other income and expense in theconsolidated statements of operations. Due to the relatively low level ofactivity to-date and the relatively steady exchange rate in Peru, translationdifferences were immaterial.

 

**Use of Estimates**

 

The preparation of the consolidated financialstatements in accordance with U.S. generally accepted accounting principlesrequires management to make certain estimates and assumptions. These estimatesand assumptions affect the reported amounts of assets, liabilities, revenuesand expenses in the consolidated financial statements, and the disclosure ofcontingent assets and liabilities. Actual results could differ from theseestimates.

 

**Reclassifications**

 

Certain prior period amounts have beenreclassified to conform to the current financial statement presentation.

 

**Cash and Cash Equivalents**

 

The Company considerscash on hand, cash in banks, money market mutual funds and highly liquid debtinstruments purchased with an original maturity of three months or less to becash equivalents. Certain of the Company’s cash balances are maintained inforeign banks which are not covered by deposit insurance. The cash balance inthe Company’s U.S. bank accounts may exceed federally insured limits.

 

****Restricted Cash****

 

As discussed in Note 7 to the Consolidated Financial Statements, theCompany has secured various performance bonds, primarily collateralized bycertificates of deposit, to guarantee its obligations and commitments in connectionwith its exploratory properties in Peru. All of the performance bonds have beenissued by Peruvian banks and their terms are dictated by the correspondingLicense Contract or Technical Evaluation Agreement.

 

**DebtFinancing Costs**

 

As discussed in Note 3 to the Consolidated Financial Statements,certain financing costs related to the acquisition of SMC Ecuador, Inc. werecapitalized. The deferred debt financing costs were amortized over the term ofthe financing.

 

****Property and Equipment****

 

The Company follows the “successful efforts” methodof accounting of its costs of acquisition, exploration and development of oiland gas properties. Under this method, oil and gas lease acquisition costs andintangible drilling costs associated with exploration efforts that result inthe discovery of proved reserves and costs associated with developmentdrilling, whether or not successful, are capitalized when incurred. Certaincosts of exploratory wells are capitalized pending determinations that provedreserves have been found. If the determination is dependent upon the results ofplanned additional wells and required capital expenditures to produce thereserves found, the drilling costs will be capitalized as long as sufficientreserves have been found to justify completion of the exploratory well andadditional wells are underway or firmly planned to complete the evaluation ofthe well. All costs related to unsuccessful exploratory wells are expensed whensuch wells are determined to be non-productive or at the one year anniversaryof completion of the well if proved reserves have not been attributed andcapital expenditures as described in the preceding sentence are not required.

 

The Company assesses its capitalized exploratorywells pending evaluation each quarter to determine whether costs should remaincapitalized or should be charged to earnings. Other exploration costs,including geological, geophysical and engineering costs, are expensed asincurred. The Company recognizes gains or losses on the sale of properties,should they occur,

 

33

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on a field-by-field basis.

 

Projects under construction are notdepreciated or amortized until placed in service. For assets we construct, wecapitalize direct costs, such as labor and materials, and indirect costs, suchas overhead and interest. As of December 31, 2005, property and equipmentconsists of office equipment, vehicles and leasehold improvements made to theCompany’s offices. All values are stated at cost and are depreciated on astraight-line basis over the estimated useful life of the assets or the term ofthe lease. Maintenance and repairs are expensed as incurred. Replacements,upgrades or expenditures which improve and extend the life of the assets arecapitalized. When assets are sold, retired or otherwise disposed, theapplicable costs and accumulated depreciation and amortization are removed fromthe appropriate accounts and the resulting gain or loss is recorded.

 

**Impairment ofLong-Lived Assets**

 

The Company periodically evaluates therecoverability of the carrying value of its long-lived assets, goodwill andidentifiable intangibles by monitoring and evaluating changes in circumstancesthat may indicate that the carrying amount of the asset may not be recoverable.Examples of events or changes in circumstances that indicate that therecoverability of the carrying amount of an asset should be assessed includebut are not limited to the following:  asignificant decrease in the market value of an asset, a significant change inthe extent or manner in which an asset is used or a significant physical changein an asset, a significant adverse change in legal factors or in the businessclimate that could affect the value of an asset or an adverse action orassessment by a regulator, an accumulation of costs significantly in excess ofthe amount originally expected to acquire or construct an asset, and/or acurrent period operating or cash flow loss combined with a history of operatingor cash flow losses or a projection or forecast that demonstrates continuinglosses associated with an asset used for the purpose of producing revenue.

 

The Company considers historical performance andanticipated future results in its evaluation of potential impairment. Accordingly,when indicators of impairment are present, the Company evaluates the carryingvalue of these assets in relation to the operating performance of the businessand future discounted and non-discounted cash flows expected to result from theuse of these assets. Impairment losses are recognized when the expected futurecash flows from an asset are less than its carrying value.

 

**Stock Based Compensation**

 

As permitted under SFAS No. 123, “Accounting for Stock-BasedCompensation,” we follow the provisions of Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Under APB25, compensation expense is recorded for stock options granted to employees anddirectors only if the current market price of the underlying stock exceeds the exerciseprice. Transactions in equity instruments with non-employees for goods orservices are accounted for under the fair value method. For periods beginningafter December 15, 2005, we will be required to account for alltransactions which result in the exchange of equity instruments for goods andservices, including stock options granted to employees and directors, underSFAS 123(R), “Share-Based Payment.” SFAS 123(R) requires that all such transactions be measured at fairvalue and recorded as an expense over the service period.

 

None of the equity instruments that we issued in exchange for goods andservices during the periods covered by this report were eligible for treatmentunder the intrinsic value method in APB 25 and all of such issuances gave riseto stock-based compensation expense based on the fair value of the instrumentsat the date of grant or issuance. Accordingly, our results of operations forthe periods presented would not have been affected had we been subject to theprovisions SFAS 123(R) for such periods.

 

**Income Taxes**

 

The Company accounts for income taxes using theliability method. Under this method, deferred tax assets and liabilities aredetermined based on differences between the financial reporting and tax basisof assets and liabilities, and are measured using the enacted tax rates andlaws that will be in effect when the differences are expected to reverse. Valuationallowances are established when necessary to reduce deferred tax assets to theamount expected to be realized.

 

**Environmental**

 

The Company is subject to environmental laws andregulations of various U.S. and international jurisdictions. These laws andregulations, which are subject to change, regulate the discharge of materialsinto the environment and may require the Company to remove or mitigate theenvironmental effects of the disposal or release of petroleum or chemicalsubstances at various sites.

 

Environmental costs that relate to currentoperations are expensed or capitalized as appropriate. Costs are expensed whenthey relate to an existing condition caused by past operations and will notcontribute to current or future revenue generation. Liabilities related toenvironmental assessments and/or remedial efforts are accrued when property orservices are provided and when such costs can be reasonably estimated.

 

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**Loss per Common Share**

 

In accordance with provisions of SFASNo. 128, Earnings per Share, basic earnings per share is computed on thebasis of the weighted-average number of common shares outstanding during theperiods. Diluted earnings per share is computed based upon the weighted-averagenumber of common shares outstanding plus the assumed issuance of common sharesfor all potentially dilutive securities. Diluted earnings per share equalsbasic earnings per share for the periods presented because the effects ofpotentially dilutive securities are antidilutive.

 

**New Accounting Pronouncements**

 

*AccountingChanges and Error Corrections*

 

In June 2005,the Financial Accounting Standards Board issued SFAS No. 154, AccountingChanges and Error Corrections, which, replaced Accounting Principles BoardOpinion No. 20, Accounting Changes (“APB 20”), and SFAS No. 3,Reporting Accounting Changes in Interim Financial Statements. SFAS 154 requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable. In contrast, APB 20previously required that most voluntary changes in accounting principle berecognized by including the cumulative effect of changing to the new accountingprinciple in net income in the period of change. SFAS 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. Earlier application is permitted for accountingchanges and correction of errors made in fiscal years beginning afterJune 1, 2005. SFAS 154 does not change the transition provisions of anyexisting accounting pronouncements, including those that are in a transitionphase as of its effective date. We have elected to adopt the provisions of SFAS154 on January 1, 2006. We do not expect adoption to have a materialeffect on our results of operations or financial position.

 

**Note 2 – Acquisition of Navidec**

 

On July 8,2004, Navidec and BPZ-Texas entered into a Merger Agreement (the "MergerAgreement") which was consummated on September 10,2004. The Merger was structured from a legal standpoint as the acquisition ofBPZ-Texas by Navidec. However, in the Merger, the stockholder group ofBPZ-Texas obtained majority ownership and management control of the combinedCompany. Accordingly, for accounting purposes, the Merger was treated as areverse merger of Navidec by BPZ-Texas. All financial statements presentedherein represent the historical financial statements of the accountingacquirer, BPZ-Texas. BPZ entered into the Merger primarily to give it access tothe public markets in financing its development activities in South America.

 

As consideration for the Merger, BPZ-Texas issued 3,198,368 shares of its common stock in a one-for-one exchange for all of the outstanding common shares of Navidec. In addition, BPZ-Texas assumed options to purchase 1,332,076 shares of Navidec common stock, which had previously been issued to employees, directors and consultants of Navidec and were outstanding on the date of the Merger. Under the terms of the Merger Agreement, the proceeds received from the exercise of these stock options are payable to NFS. BPZ-Texas also assumed outstanding warrants to purchase 1,129,000 shares of Navidec common stock. In addition, BPZ-Texas granted to NFS fully vested warrants to purchase 1,500,000 shares of common stock at an exercise price of $2.00 per share and issued 662,149 new shares of common stock to NFS. See Note 9 of the Notes to Consolidated Financial Statements for details about the stock options and warrants assumed or granted in connection with the Merger.

 

The aggregate consideration given by BPZ-Texas for the acquisition of Navidec was $7,498,924, consisting wholly of equity securities issued. The BPZ-Texas stock issued in connection with the acquisition was valued at $1.48 per share, which was the average closing price of Navidec’s common stock quoted on the OTCBB market during a five-day trading period beginning two trading days prior to the announcement of the Merger Agreement on July 8, 2004. Navidec was publicly traded and had a market for its equity while BPZ-Texas was privately owned. The stock options assumed and warrants issued or assumed were valued using the Black-Scholes model. Inputs into the Black–Scholes valuation model for the valuation of the warrants and stock options included the exercise price and remaining term for the stock options and warrants, and a volatility factor based on historical stock prices of Navidec. The Merger has been accounted for using the purchase method of accounting, in accordance with SFAS No. 141. The results of operations of Navidec have been included in the Company’s results since September 1, 2004, for convenience purposes.

 

The following summarizes the purchase consideration given for the acquisition of Navidec:

 

**Purchase Consideration**

 
| **Description**                             | ** ** | **Shares** | ** ** | **Purchase Consideration** | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------------|------------|
| Common stock issued to Navidec shareholders |       | 3,198,368  |       | $                          | 4,733,585  |   |
| BPZ common stock issued to NFS              |       | 662,149    |       | 979,980                    |       |
| BPZ warrants issued to NFS                  |       | 1,500,000  |       | 705,000                    |       |
| Assumption of Navidec stock options         |       | 1,332,076  |       | 865,849                    |       |
| Assumption of Navidec warrants              |       | 1,129,000  |       | 214,510                    |       |
| Total purchase consideration                |       |       |       | $                          | 7,498,924  |   |

 

35

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BPZ allocated the purchase price to assets acquired and liabilities assumed at estimated fair values on the acquisition date, September 10, 2004. The excess of purchase price over the fair value of the net assets acquired as of the acquisition date has been reflected as goodwill in accordance with SFAS No. 141. The following summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:

 

**PurchasePrice Allocation**

 
| ** **                                                                  | ** ** | **Value**     | ** ** |
|-----------------------------------------------------------------------------|------------|---------------|------------|
| **Description**                                                             | ** ** | **Allocated** | ** ** |
| BPZ common stock issued to NFS (662,149  shares)                            |       | 2,125,498     |       |
| Warrants to purchase BPZ common stock  issued to NFS (1.5 million warrants) |       | 2,640,000     |       |
| Goodwill and intangible assets                                              |       | 2,400,753     |       |
| Other assets and liabilities of NFS, net                                    |       | 332,673       |       |
|                                                                        |       |          |       |
| Total purchase price allocation                                             |       | $             | 7,498,924  |   |
|                                                                             |            |               |            |  |

 

The purchase price paid for Navidec, Inc. is attributable solely to the value of NFS, Inc., an entity which is required to be spun-off, as discussed below. Accordingly, the purchase price is recorded under the caption, Investment in Navidec Financial Services, Inc. See Note 6 to the Consolidated Financial Statements for further details. Additionally, as disclosed in Note 9 to the Consolidated Financial Statements, the value of the Company’s common stock and warrants held by NFS are recorded as treasury securities.

 

Of the amounts shown above, $681,220 in cash and marketable securities has been allocated to other assets instead of a reduction to the purchase price because the cash remained with NFS following the Merger and is not available for use by the Company. The tax consequences of the merger have not been fully analyzed. However, it is believed that the excess of the purchase price over the net assets acquired will not be deductible for tax purposes.

 

The following unaudited information presents the pro forma effects of the Merger as if it had occurred on January 1, 2004:

 

**Pro Forma Effects of the Merger**

 
| ** **                                  | ** ** | **2004**   | ** **  |
|---------------------------------------------|------------|------------|-------------|
| Revenues                                    |       | $          | —      |   |
| Net loss                                    |       | $          | (11,191,671 | ) |
| Net loss per  share (basic and diluted)     |       | $          | (0.81       | ) |
| Weighted  average common shares outstanding |       | 13,831,628 |        |

 

**NFS Spin-off**

 

The Merger Agreement also required the transfer of all of thepre-merger business assets and liabilities of Navidec to its wholly ownedsubsidiary, NFS, and the spin-off of NFS common stock to the shareholders ofrecord of Navidec as of September 9, 2004, the date prior to theMerger.  Upon consummation of the Merger, BPZ became contractually andirrevocably bound to the spin-off of NFS to such pre-Merger shareholders. Alllegal requirements for the spin-off of NFS have been completed except for thefiling of a registration statement with the Securities and Exchange Commissionand the final distribution of NFS common shares to the pre-merger shareholdersof the Company. Pending such final distribution of NFS common shares, theCompany remains the nominal owner of those shares, which are being held for thebenefit of the spin-off shareholders. The Company accounts for its nominalinvestment in NFS under the equity method, as discussed in Note 6 of the Notesto Consolidated Financial Statements. As of December 31, 2005, the Company’snet investment in NFS is zero. As a result, future NFS losses will not berecorded by the Company. The Company has no control over the registrationprocess of NFS and cannot predict when the management of NFS will be able tocomplete the final distribution of NFS common shares.

 

**Note 3 – Other Current Assets**

 

Below is a summary of other current assets as of December 31, 2005 and 2004:

 
| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
|                        |       |     |       |     |       |
| Value added tax             |       | $        | 362,555    |     | $          | — |   |
| Prepaid  expenses and other |       | 270,903  |       | 4,597    |       |
| Deposits                    |       | 181,347  |       | —   |       |
| Deferred financing costs    |       | —   |       | 67,562   |       |
| Interest receivable         |       | 54,864   |       | —   |       |
|                        |       |     |       |     |       |
|                        |       | $        | 869,669    |     | $          | 72,159 |   |

 

36

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Value-added tax (referred to as “IGV” inPeru) is generally imposed on goods and services at a rate of 19%. Certainexpenditures are exempt from IGV or eligible for immediate refund. IGV paid oncapital expenditures is generally recoverable from future revenue billingswithin Peru and is not considered part of the capitalized costs of theequipment to which it relates. The Company has applied for early recovery ofIGV paid as it does not anticipate first sales of power to the Peruvianpower market until2007. Prepaid expenses are primarily related to crane, barge and bargeequipment rentals which will be credited against the monthly charter or dailyrates once operations commence. Deposits are primarily to secure delivery ofthe drilling rig and rent deposits in connection with the Company’s offices inHouston and Peru.

 

Deferred financing costs at December 31,2004 consisted primarily of capitalized financing costs related to theacquisition of SMC Ecuador, Inc. The Company amortized these costs toexpense over the term of the financing.

 

**Note 4 — Property, Equipment and Construction in Progress**

 

Below is a summary of property, equipment and construction in progress as of December 31, 2005 and 2004:

 
| ** **                                              | ** ** | **2005**  | ** ** | **2004** | ** ** |
|---------------------------------------------------------|------------|-----------|------------|----------|------------|
|                                                    |       |      |       |     |       |
| Construction in progress:                               |       |      |       |     |       |
| Power plant and related equipment                       |       | $         | 2,252,413  |     | $          | — |   |
| Platforms and wells                                     |       | 1,190,707 |       | —   |       |
| Pipelines and processing facilities                     |       | 512,357   |       | —   |       |
| Office equipment, leasehold improvements,  and vehicles |       | 439,359   |       | 5,662    |       |
| Accumulated depreciation and amortization               |       | (29,796   | )          | (157     | )          |
|                                                    |       |      |       |     |       |
| Net property, equipment and construction in  process    |       | $         | 4,365,040  |     | $          | 5,505 |   |

 

In 2005 the Company incurred costs associatedwith development and production of natural gas reserves and with thecomplementary development of gas-fired power generation for its own use inPeru. The costs relate to the initial engineering design work for the powerplant, gas processing facility and pipeline, and acquiring and refurbishing oneof the Company’s offshore platforms located in Block Z-1. The Company incurredcosts for office equipment and leasehold improvements for its offices inHouston, Peru and Ecuador and for vehicles used in the Peruvian operations.

 

**Note 5 – Investment in Ecuador Property and NotePayable**

 

The Company has an investment in an oil and gas property in Ecuador(the “Santa Elena Property”) totaling $1,945,188 as of December 31, 2005. TheCompany accounts for this investment under the cost method and records itsshare of cash received or paid as other income or expense. Since the Company’sinvestment represents ownership of an oil and gas property, which is adepleting asset, the Company is amortizing the cost of the investment on a straight-linebasis over the remaining term of the license agreement which expires inMay 2016. Accordingly, the Company recorded amortization expense of$136,552 and $42,760 for the years ended December 31, 2005 and 2004,respectively.

 

In connection with theacquisition of the Santa Elena property, the Company had a note payable balanceof $208,986 as of December 31, 2004. The note agreement required monthlyinstallment payments of $31,366, including imputed interest at 15%, throughJuly 1, 2005 and has been paid in full as of December 31, 2005.

 

As part of the note agreement, the holder of the note payable received beneficial ownership of a 4% net working interest in the Santa Elena Property. In June 2005, the Company entered into an agreement to issue 250,000 shares of the Company’s common stock, valued at $1,112,500, to acquire the holder’s 4% net working interest in the property. Accordingly, as of December 31, 2005, the Company owned the full 10% working interest in the Santa Elena Property.

 

**Note 6 – Investment in Navidec Financial Services(NFS)**

 

As discussed in Note 2to the Consolidated Financial Statements, the Company is contractually bound tospin-off NFS to the pre-merger shareholders of Navidec.  Pending thedistribution of NFS common shares to the beneficiaries of the spin-off, theCompany is the nominal owner of those shares.  While the Company may bedeemed to have majority nominal ownership of the common stock of NFS, it doesnot control NFS.  As such, the Company has determined that the equitymethod of accounting is the most appropriate manner to reflect its nominalownership of NFS during the period of time between the Merger and its ultimatespin-off to the pre-merger shareholders of Navidec.

 

37

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As of the date of theMerger, September 10, 2004, NFS had 5,177,548 common shares outstanding, whichshares are held by the Company for the benefit of the spin-offshareholders.  On September 21, 2004, the Board of Directors of NFSawarded to the management of NFS 1,200,000 fully vested NFS common shares andoptions to purchase an additional 1,200,000 NFS common shares at a cost of$0.05 per share.  This transaction resulted in the nominal ownership ofBPZ being reduced from 100% to 81.2% (68.3% on a fully diluted basis) atDecember 31, 2004. During 2005, NFS issued 1,332,500 common shares andwarrants to purchase 2,665,000 common shares in connection with a privateplacement. In addition, NFS issued stock options to purchase 1,875,000 sharesof NFS stock to directors, employees, consultants and others. An option topurchase 250,000 common shares at an exercise price of $0.05 per shares wasexercised during 2005.  In total, 2,782,500 shares of common stock havebeen issued and 5,490,000 potentially dilutive securities (options, warrantsand a contingent issuance in connection with an acquisition) have been issuedby NFS since the date of the merger.  As a result of these issuances, thenominal ownership of BPZ has been reduced to 65.1% (40.8% on a fully dilutedbasis) as of December 31, 2005.

 

To the extent that NFSconveys its shares or stock options to third parties for a per-share value lessthan the Company’s nominal basis in its investment in NFS, the issuance ofthese shares or stock options by NFS will result in a loss to theCompany.  The issuance of common shares and stock options by NFS resultedin a recorded loss to the Company of $1,785,000 during 2004. Issuances in 2005,in the aggregate, have been at an amount in excess of BPZ’s basis per share. The Company’s policy is not to recognize a net gain on equity issuances by NFSfor amounts in excess of BPZ’s basis per share.  However, such gains wereused to offset losses previously recorded in the current fiscal year.

 

Additionally, pursuantto the Merger Agreement, NFS is entitled to the proceeds received from theexercise of pre-merger stock options which were assumed by the Company in theMerger.  During the period from the effective date of the Merger throughDecember 31, 2004 and for the year ended December 31, 2005, NFS received stockoption proceeds of $343,000 and $631,000, respectively.  This amount istreated for accounting purposes as an additional investment in NFS by theCompany.  To the extent that the Company has less than 100% nominalownership of NFS, the receipt of stock option proceeds by NFS results in a lossto the Company based on the minority interest in NFS.  The Companyrecorded a loss of $108,000 during 2004 attributable to these stock optionexercises. A loss of $224,000 in 2005 was not recorded because it was offset bygains on other equity issuances by NFS as described above.

 

NFS recognized a netloss of $2,419,000 during the period from the date of the Merger throughDecember 31, 2004 and a net loss in 2005 of $3,171,000. Based on its 81.2%nominal ownership interest in NFS at December 31, 2004, the Company recorded anequity loss of $1,964,000 for 2004. Based on its nominal ownership interest inNFS (ranging from 78.1% to 65.1%), the Company recorded an equity loss of $2,157,000for the year ended December 31, 2005.

 

The Company will notbenefit economically from any positive operating results of NFS because it doesnot have beneficial ownership of or access to the cash or other assets ofNFS.  The Company is not entitled to receive any distributions ordividends from NFS, nor could it cause NFS to declare a dividend because itdoes not control NFS.  Additionally, the Company is not directly orindirectly obligated for the liabilities, commitments or other obligations ofNFS.  Although, the Company’s reported financial results have beenmaterially affected by NFS’ operating results these adverse results do notaffect the cash flows of the Company. In addition, as of December 31, 2005, theCompany’s investment in NFS is zero. The Company is not obligated to fundadditional losses of NFS and will not record future losses of NFS in excess ofits net investment.

 

NFS will continue tobe reflected as an equity investment in the financial statements of the Companyuntil such time as the final distribution of NFS shares in the spin-off isconsummated.  This is expected to require an effective registrationstatement with the SEC.  The Company has no control over the registrationprocess of NFS and cannot predict when the management of NFS will be able tocomplete the final distribution of NFS common shares. The Company’sstockholders’ equity will not be affected at such time as the spin-off isconsummated, because the Company’s net investment in NFS is zero as of December31, 2005.

 

The Company presentsits investment in NFS net of the reclassification of BPZ common stock andwarrants held by NFS as treasury securities, as discussed in Note 9 to theConsolidated Financial Statements. The following table presents the activity inthe Company’s investment account for NFS for the period from the effective dateof the Merger through December 31, 2005:

 

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| ** **                                                            | ** ** | **Year ended  December 31, 2005** | ** ** | **For the period  from September  10, 2004 through  December 31, 2004** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------------------|------------|
|                                                                  |       |                              |       |                                                                         |       |
| Investment in NFS, beginning balance                                  |       | $                                 | 3,985,000  |                                                                         | $          | — |   |
| Acquisition of NFS                                                    |       | —                            |       | 7,499,000                                                                    |       |
| Equity in loss of NFS                                                 |       | (2,157,000                        | )          | (1,964,000                                                                   | )          |
| Loss on issuance of equity securities by  NFS                         |       | —                            |       | (1,785,000                                                                   | )          |
| Proceeds received by NFS from exercise of  stock options              |       | 631,000                           |       | 343,000                                                                      |       |
| Loss on exercise of stock options                                     |       | —                            |       | (108,000                                                                     | )          |
| Ending investment before treasury  securities elimination             |       | 2,459,000                         |       | 3,985,000                                                                    |       |
| Less treasury securities (BPZ common stock  and warrants held by NFS) |       | (2,459,000                        | )          | (2,854,000                                                                   | )          |
| Investment in NFS, ending balance                                     |       | $                                 | —     |                                                                         | $          | 1,131,000 |   |

 

**About NFS**

 

NFS was formed inDecember 2002, with its principal office in Denver, Colorado, and isorganized into three divisions: business development, mortgage services and technology. The business development division focuses on identifying development stagecompanies and assisting in their growth by providing capital, consulting,personnel and other services, both internally and through the use ofsubcontractors.  The mortgage division provides loan origination andrefinancing services in the residential and commercial mortgage market,primarily in the Phoenix, Arizona area.  In April 2005, NFS acquiredAegis Business Group, Inc. (“Aegis”), a technology company that developsand markets security solutions related to identity and computer accessmanagement. Aegis was sold in December 2005 to two individuals, one of whom isan officer of NFS and one of whom was a director of NFS at the time. The gainon sale of Aegis, representing the recovery of prior losses, was deferred byNFS at December 31, 2005 based on uncertainty over the collectibility of thenote receivable.

 

###### **Note7 – Restricted Cash**

 

As of December 31, 2005, the Company had posted performance bondstotaling $1,690,000 to secure the performance of its obligations andcommitments related to its properties in Peru. Of such amount, $1,455,953 iscollateralized by a restricted cash deposit. The remaining $240,000performance bonds have been guaranteed by two individual shareholders of theCompany.

 

As of December 31, 2004, the Company had posted performance bondstotaling $340,000 to secure the performance of its obligations and commitmentsrelated to its properties in Peru. Of such amount, $100,000 was collateralizedby a restricted cash deposit. The $100,000 restricted cash deposit wasclassified as a current asset as the Company had met its obligations under thelicense contract and the performance bond expired in March 2005. Theremaining $240,000 performance bonds were guaranteed by two individualshareholders of the Company.

 

All of theperformance bonds were issued by Peruvian banks and their terms are governed bythe corresponding license contract or technical evaluation agreement.

 

###### **Note8 – Long-Term Debt**

 

On December 31, 2005,the Company had long-term debt of $70,908, consisting of two secured loans forthe purchase of office furniture. Both loans have a term of 60 months, bearinginterest at 5.94% and 9.44%, with principal and interest payments due on amonthly basis. There wasno long-term debt outstanding at December 31, 2004.

 

**Note 9 – Stockholders’ Equity**

 

The Company has 250,000,000 shares of common stock, no par value, and 25,000,000 shares of preferred stock authorized for issuance. The common shares issued and outstanding at December 31, 2005 and 2004 are set forth below. For accounting purposes, the common shares held by NFS attributable to the Company’s equity interest in NFS are reflected as treasury shares. There were no preferred shares issued or outstanding as of December 31, 2005.

 
| ** **                                             | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Common shares issued                                   |       | 40,349,979            |       | 16,581,385            |       |
|                                                   |       |                  |       |                  |       |
| Common shares owned by NFS                             |       | 707,903               |       | 557,903               |       |
| Company’s equity interest in NFS                  |       | 65.1                  | %          | 81.2                  | %          |
| Net common shares held by affiliate  (treasury shares) |       | 460,450               |       | 452,931               |       |
|                                                   |       |                  |       |                  |       |
| Common shares outstanding                              |       | 39,889,529            |       | 16,128,454            |       |

 

In connection with the private placement of11,466,000 common shares, the Company was obligated to prepare and file withthe SEC a Registration Statement on Form SB-2 and to use its best effortsto cause the Registration Statement to be declared effective by the SEC nolater than ninety days from July 19, 2005. The Registration Statement wasnot declared effective by the required date and the Company became liable tothe Investors for liquidated damages in an amount equal to 1.0% of the purchase

 

39

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price of the shares,approximately $343,980, for each thirty day period until the Registration Statementis declared effective by the SEC. Certain of the private placement investors,totaling 79% of the aggregate investment, have agreed to accept common stock inlieu of cash for a maximum period of 90 days. As of December 31, 2005, theCompany recorded registration delay expense totaling $515,967 of whichapproximately $407,937 of which $271,960 was paid by the issuance of 92,705shares of common stock and $135,977 was paid subsequent to December 31, 2005 bythe issuance of 49,596 shares of common stock. As of March 31, 2006, theCompany’s Registration Statement on Form SB-2 had not been declaredeffective by the SEC and Company continues to be liable to the Investors forthe aforementioned liquidated damages.

 

**Common Stock and Warrants Held by Affiliate**

 

As discussed in Note 2 to the Consolidated Financial Statements, NFS holds common stock and warrants in the Company. For accounting purposes, these common shares and warrants are treated as treasury securities and are recorded as a reduction of stockholders’ equity at the initial recorded value. As of December 31, 2005, NFS held 707,903 shares of the BPZ common stock and unexercised warrants to purchase 810,000 shares of BPZ common stock at an exercise price of $2.00 per share. The BPZ common stock and warrants held by NFS attributable to the Company’s 65.1% interest in NFS have an aggregate recorded value of $2,458,975, excluding unrealized gains or losses since the date of the Merger.

 

**Stock Subscription Receivable**

 

During 2004, the Company issued 236,528 shares to an individual investor for $119,175 of cash proceeds and a subscription receivable of $230,825. The investor has pledged assets to a Peruvian bank which secure one of the Company’s performance bonds. The subscription receivable is due at such time as the Company obtains its own performance bond to replace the one posted by the investor or until the performance bond is no longer required.

 

**Potentially Dilutive Securities**

 

In addition to the shares issued and outstanding, the Company has the following potentially dilutive securities. None of these potentially dilutive shares have been included in the calculation of earnings per share as the effect would be anti-dilutive.

 
| ** **                                                          | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                          | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Stock  options outstanding                                          |       | 1,653,652             |       | 2,055,041             |       |
| Warrants  outstanding                                               |       | 1,325,000             |       | 2,629,000             |       |
| Shares  issuable to consultant for services                         |       | 10,000                |       | —                |       |
| Contingent  incentive earn-out shares                               |       | 485,000               |       | —                |       |
| Shares  available pursuant to Long-Term Incentive Compensation Plan |       | 2,880,000             |       | —                |       |
| Earn-out  shares                                                    |       | —                |       | 9,000,000             |       |
| Contingent  Merger earn-out shares                                  |       | 9,000,000             |       | 9,000,000             |       |
| Total potentially dilutive securities  issued                       |       | 15,353,652            |       | 22,684,041            |       |

 

**Stock Options Outstanding**

 

In connection with the Merger, BPZ, as theaccounting acquirer, assumed all Navidecstock options outstanding, which were fully vested on the date ofthe Merger and expire on September 10, 2007. Exercise prices onthese stock options range from $1.30 to $1.93 per share. Under the terms of theMerger agreement, NFS is entitled to receive all proceeds from the exercise ofthese options. As of December 31, 2004, there were 1,055,041 Navidec stockoptions outstanding. During the year ended December 31, 2005, 401,389Navidec stock options were exercised and 653,652 were outstanding as of the endof the period.

 

Additionally, the Companygranted options to purchase 1,000,000 shares of common stock at an exerciseprice of $1.30 per share to the former CEO of Navidec in connection with hisservice as a director and financial consultant to the Company. Of such stockoptions, 500,000 were fully vested on the date of the Merger. Vesting of theremaining 500,000 stock options is contingent upon the receipt of additionalinvestment proceeds totaling $6 million, including proceeds from the exerciseof outstanding warrants, provided such funding is received no later thanSeptember 10, 2006. These stock options, when vested, will expire 10 yearsfrom the date of grant. They were recorded at a fair value of $1.20 per shareusing the Black-Scholes model. The unvested options are being amortized overthe 24-month vesting period at the rate of $25,000 per month unless the Companyconcludes that suchoptions are no longer probable of vesting.

 

All of the above stockoptions were recorded at fair market value on the date of the Merger. Accordingly,no disclosure of pro forma results of operations under SFAS 123 is required.

 

**Warrants Outstanding**

 

In connection with theMerger, BPZ, as the accounting acquirer, assumed outstanding warrants topurchase 1,129,000 shares of the Company’s common stock. Of this total, 564,500Class A warrants had an exercise price of $2.00 per share and 564,500Class B warrants had an exercise price of $4.00 per share. All of suchwarrants were scheduled to expire during 2005. As

 

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of December 31, 2005, withthe exception of 500 of the Class A warrants, all of such warrants had beenexercised, resulting in net proceeds to the Company of $3,318,260.

 

In connection with the Merger, BPZ alsoissued warrants to purchase 1,500,000 shares of common stock at an exerciseprice of $2.00 per share to NFS. Such warrants expire on July 31, 2006. Subsequentto the Merger, NFS conveyed 540,000 of such warrants to third parties. During2005, 275,000 warrants had been exercised, resulting in net proceeds to theCompany of $550,000. As of December 31, 2005 there were 1,225,000 of suchwarrants outstanding, of which 810,000 were held by NFS.

 

In connection with the private placement of 11,466,000 shares of common stock, Morgan Keegan & Company, Inc. also received warrants to purchase 100,000 shares of the Company’s common stock at an exercise price of $3.00 per share. Such warrants expire on July 19, 2010. These warrants were valued at $325,000 using the Black-Scholes model, which amount was treated as additional non-cash stock offering costs.

 

**Shares Issuable for Services**

 

The Company has a contingent obligation to issue 10,000 shares to a consultant for legal and business advisory services to be rendered in Peru, on May 21, 2006, pursuant to a service agreement.

 

**Contingent Incentive Earn-Out Shares**

 

During 2005, the Company’s Board of Directorsawarded a total of 485,000 shares of incentive stock awards to three of theCompany’s officers. Vesting of the incentive stock awards is contingent on theCompany achieving net production of 2,000 barrels of oil per day or itsequivalent (approximately 12 million cubic feet of gas per day) prior toDecember 28, 2007, the same target as the Merger earn-out shares (seebelow). The total future stock-based compensation expense associated with thesecontingent incentive stock awards is $2,134,000 ($441,517 for 2005). As theCompany has not yet obtained a firm financing commitment for its gas-to-powerproject, the Company does not consider the achievement of this target to beprobable for accounting purposes and is not currently accruing the associatedstock-based compensation expense.

 

**Long-Term Incentive Compensation Plan**

 

TheBPZ Energy, Inc. 2005 Long-Term Incentive Compensation Plan (the “LTIP” or“Plan”) permits the Board of Directors to award eligible employees, directorsand consultants with incentive-based and non-incentive-based compensation. Themaximum number of shares of Stock of the Company that may be subject to incentivesunder the Plan, including without limitation is 4,000,000 shares, and suchshares shall be reserved at all times until issued under the Plan. Of suchamount, no more than 1,600,000 shares in the aggregate shall be eligible forthe issuance of performance shares, stock grants, restricted stock grants and otherstock-based incentives. The LTIP will be administered and managed within thediscretion of compensation committee of the Company or, in the absence of suchcommittee, by the Board of Directors. Incentives under the LTIP may be grantedto eligible employees, directors or consultants in any one or a combination ofincentive options, non-statutory stock options, stock appreciation rights,restricted stock grants, stock grants and performance shares. As of December31, 2005 there were 2,880,000 of such shares available to be granted by theCompany.

 

**Merger Earn-Out Shares**

 

Under the terms of the Merger Agreement, the Companyis committed to issue 18,000,000 shares to the former shareholders of BPZ-Texason a contingent earn-out basis if the Company achieves certain reserve andproduction goals. The first earn-outtarget relating to reserves was achieved in December 2004 and 9,000,000 ofthe earn-out shares were issuable at that time. However, the contingentearn-out shares could only be issued after the shareholders approved anincrease in the number of authorized common shares of the Company. Theshareholders approved an increase in the number of authorized shares from20,000,000 to 250,000,000 at its 2005 Annual Meeting held on July 1, 2005and the 9,000,000 shares were issued at that time. The remaining 9,000,000 earn-out shares are contingent on the Companyachieving production of 2,000 barrels of oil per day or its equivalent(approximately 12 million cubic feet of gas per day) prior to December 28,2007.

 

For accounting purposes, the earn-out arrangement istreated as a stock dividend because the earn-out is payable to the shareholdersof the accounting acquirer, BPZ-Texas. Accordingly, except for an increase inthe number of common shares outstanding, no accounting entry is required uponthe issuance of the earn-out shares.

 

**Note 10 – Affiliate and Related Party Transactions**

 

As of December 31, 2005 and December 31,2004, the Company had no outstanding balances with affiliates or relatedparties. As of December 31, 2003, BPZ-Texas, the reporting entity in thesefinancial statements, had a net receivable of $162,890 due from BPZ andAssociates, the parent of BPZ-Texas prior to the Merger. Additionally, during2004, BPZ-Texas made additional cash payments to BPZ and Associatestotaling $789,438. Of such payments, $370,000 related to the acquisition of SMCEcuador, Inc., with $167,500 paid to third parties and $202,500 paid forthe benefit of BPZ and Associates. The remaining amount of $582,328 wasattributable to personnel and office expenses incurred by BPZ andAssociates on behalf of BPZ-Texas and has

 

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been recorded as part ofgeneral and administrative expenses during the year ended December 31, 2004.

 

**Note 11 – Income Taxes**

 

There was no income tax expense or benefitfor the years ended December 31, 2005 and 2004. The following tablereconciles income taxes at the statutory rate to the Company’s effective ratefor the years ended December 31, 2005 and 2004:

 
| ** **                                       | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|--------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                             |       |      |       |      |       |
| Benefit computed at the expected statutory  rate |       | $         | (2,911,708 | )         | $          | (3,621,908 | ) |
| Less: valuation allowance                        |       | 2,911,708 |       | 3,621,908 |       |
| Income tax expense                               |       | $         | —     |      | $          | — |   |

 

**Note 12 – Commitments and Contingencies**

 

The Company has various obligations andcommitments in connection with its properties in Peru. In connection with itsBlock Z-1 property, the Company posted a $1,300,000 performance bond inJanuary 2005. To satisfy its current performance obligation under thesecond exploration phase of the Block Z-1 license agreement, the Company mustdrill at least one well or acquire a specified amount of seismic data prior toJuly 2006. The Company intends to satisfy its obligation by drilling awell which is currently budgeted to cost approximately $5,000,000. In addition,in connection with its Block XIX property, the Company posted a $350,000performance bond in August 2005. To satisfy its current performanceobligation under the second exploration phase of the Block XIX licenseagreement which began in August 2005 and will last for 24 months, theCompany must acquire and process a specified amount of 2-D seismic data andprepare an integrated geological, geochemical and reservoir engineeringevaluation of hydrocarbon prospects.

 

The Company acquired four offshore platforms inconnection with its Block Z-1 property. The Company is currently in the processof refurbishing one of the offshore platforms and intends to maintain all ofsuch platforms for use throughout the life of the Block Z-1 contract. Theseplatforms revert back to the Government of Peru at the end of the contract,provided they are in good working condition, with no further obligation to thecompany to dismantle or remove them. The Company and its legal advisors havereviewed Peruvian law and existing regulations from the Peruvian Ministry ofEnergy and Mines in conjunction with the requirements of FAS 143 “Accountingfor Asset Retirement Obligations” (“ARO”) as it applies to tangible long livedassets and their future retirement and dismantlement. The Company has concludedthat there is no legal obligation to dismantle the platforms, as defined in FAS143, and therefore recognition of an ARO is not required. Accordingly, no suchprovision is reflected in the accompanying consolidated financial statements. If, however, current laws or regulations werechanged or the platforms were no longer in good working order, the Companycould be obligated to dismantle and remove them. The current estimated cost todismantle an offshore platform is estimated to be approximately $2 million,depending upon the condition of the platform and the depth of the water.

 

On May 27, 2005, BPZ signed a Mandate Letterwith the International Finance Corporation (“IFC”), a member of the World BankGroup based in Washington, D.C., to facilitate the financing of the Company’sinitial capital expenditure program in Block Z-1 in northwest Peru. OnNovember 1, 2005, an amendment was signed extending the original term ofthe Mandate Letter from December 31, 2005 to August 31, 2006. TheMandate Letter specifies that IFC will appraise BPZ’s project in Peru todetermine the feasibility and structure of a potential financing transaction. AnyIFC investment will depend on the project and the Company meeting IFC’sfinancing criteria, the overall financing plan being acceptable to IFC,approval of the investment by management and the Board of IFC, and theexecution of all appropriate documentation, in form and substance satisfactoryto IFC. As part of the Mandate, BPZ agreed to pay total fees of $285,000 duringthe appraisal period and customary expenses. As of September 30, 2005,$85,000 of fees and approximately $8,200 of reimbursable out-of-pocket expenseshad been incurred.

 

In December 2005, the Company signed adrilling contract with Petrex S.A., a subsidiary of Saipem SpA of Italy. Underthe contract, Petrex S.A. will provide a platform rig capable of drilling to16,000 feet and upgrade the rig to meet the Company’s specifications. TheCompany intends to utilize the rig for the initial development of the Corvinagas field and may also utilize it for the expected development of the Albacoraoil field, and potential appraisal wells in the Piedra Redonda gas field. TheCompany has agreed to pay a $5.5 million fee to mobilize and upgrade the rig. Inexchange, the Company will receive a competitive fixed day rate and exclusiverights to use the rig, at its option, during the two-year period commencingwith delivery of the rig.

 

In December 2005, the Company notified Perupetro that it has exercised its exclusive option to convert the current Technical Evaluation Agreement (“TEA”) in Area VI, which covers 1,444,175 acres and encompasses the entire Lancones Basin, to a License Contract for the exploration and development of hydrocarbons. In addition, the Company announced that it will not apply for a license contract for Area XVI.

 

The Company will continue to make commitmentsin the ordinary course of business as it pursues its development plans for theproperties.

 

42

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**Note 13 – Legal Proceedings**

 

Navidec, Inc. was advised in a letter dated February 24, 2004 that the SEC was conducting an informal inquiry to determine whether Navidec, Inc. had violated federal securities laws. The SEC made an informal request that Navidec voluntarily produce certain documents, which were provided to the SEC in May 2004. Based on the inquiries made and the information requested, the Company believes that the SEC’s investigation relates, at least in part, to the restatement of reported earnings for the first and second quarters of 2003 by Navidec, Inc. This restatement was reported in Navidec, Inc.’s Form 10-Q for the third quarter of 2003 filed on December 11, 2003.

 

In December 2004, theCompanyreceived notice that the SEC had issued an Order Directing a PrivateInvestigation and Designating Officers to Take Testimony, and would beconducting a formal investigation. BPZ is cooperating fully with the SEC in this matter. As ofDecember31, 2005, a total of approximately $50,000, primarily in legal fees,had been incurred in connection with the SEC investigation. Pursuant to theMerger Agreement,the Company hasbeen indemnified by NFS for the costs of the SEC investigation and NFS has borne the costsincurred to date. BPZ is not aware of the future actions, if any, which the SEC intends to pursue inthis matter, but no assurance can be given that the investigation will beresolved without negativeconsequences to the Company.

 

In February 2006, BPZ filed a petition in theDistrict Court of Arapahoe County, Colorado for the judicial dissolution ofNavidec Financial Services, Inc. (“NFS”) and the appointment of a receiver forNFS. BPZ is seeking this action on behalf of those shareholders entitled to thespin-off of NFS shares pursuant to the Merger Agreement with Navidec, Inc.dated July 8, 2004. Despite the fact that the Merger was consummated inSeptember 2004, the spin-off has not occurred and it appears highly unlikely orimpossible that it will be completed. BPZ is the record owner of approximately65% of the common shares of NFS, although the pre-merger shareholders ofNavidec, Inc. are the ultimate beneficiaries of the spin-off. Accordingly, BPZclaims no beneficial interest in NFS. The directors of BPZ believe that theliquidation of NFS and distribution of the net cash value to the beneficialowners is the most viable option to accomplish the intent and spirit of thespin-off and is the best financial alternative for such owners. Additionally, webelieve that the appointment of a receiver is necessary to independently manageand wind-up the affairs of NFS. This matter is being contested by NFS and theCompany cannot predict the outcome or timing of this matter.

 

**Note 14 – Minimum Lease Payments**

 

**TheCompany leases office space in Houston, Texas under a five-year operating leaseand in Lima, Peru under a month-to-month operating lease. Total rent expenseincurred for the years ended December 31, 2005 and 2004 was approximately$98,000 and $18,000 respectively.**

 

**Note 15 – Subsequent Events**

 

On March 10, 2006 the Company completed a private placement of1,670,000 shares of common stock, no par value, to four institutional andaccredited investors pursuant to a Stock Purchase Agreement dated as of March8, 2006. The common stock was priced at $3.00 per share resulting in proceedsto the Company of approximately $5.0 million. In connection with the offer andsale of the common stock in the private placement, the Company relied on anexemption from registration under Section 4(2) of the Securities Act of 1933,as amended, and Regulation D, Rule 506 promulgated there under. The sale ofcommon stock was made to accredited investors as defined in Regulation D, Rule501(a). In the Stock Purchase Agreement, the Company agreed to prepare and filewith the Securities and Exchange Commission (“SEC”), no later than 60 daysafter the closing date of the private placement, a registration statementcovering resale of the shares of common stock issued in the placement. TheCompany also agreed to use its best efforts to cause the registration statementto be declared effective no later than 5 business days after the Companyreceives a notice that the SEC will not review the registration statement or 90days after the closing date if the SEC reviews the registration statement. Ifthe Company fails to file the registration statement before the deadline forsuch filing, or the registration statement is not declared effective within 30days of the deadline for it to be declared effective, the Company will beobligated to the Investors for liquidated damages in an amount equal to1.0% of the purchase price of the shares, for each thirty day period until theRegistration Statement is declared effective by the SEC.

 

**Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures**

 

None.

 

**Item 8A. Controls and Procedures**

 

**(a) Evaluation of Disclosure Controlsand Procedures**

 

As of the end of the period covered by this report,we carried out an evaluation, under the supervision and with the participationof our management, including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of our disclosure controls and procedures asdefined in Rule 13a-15(e) of the Exchange Act. Based upon that evaluation, as aresult of the

 

43

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restatement issue discussedbelow, our Chief Executive Officer and Chief Financial Officer concluded thatour disclosure controls and procedures were not effective as of the end of theperiod covered by this report to provide reasonable assurance that informationrequired to be disclosed by the Company in the reports that the Company filesor submits under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms.

 

On November 17, 2005, the Company concluded that itneeded to restate its previously issued Consolidated Financial Statements as ofand for the year ended December 31, 2004. The Company also restated itsfinancial statements for the quarterly periods ended March 31, 2005 and June30, 2005. On January 17, 2006, the Company amended its aforementioned filingswith the SEC on Form 10-KSB/A and Form 10-QSB/A, as appropriate, and are herebyreferenced by incorporation. The primary purpose of the restatement was toreflect the previously unrecorded nominal ownership interest in NavidecFinancial Services, Inc. (“NFS”) using the equity method of accounting and itseffects on the accounting treatment of the Merger with Navidec, Inc. Managementof the Company had previously concluded that the spin-off of NFS had beenlegally consummated as of the Merger date on September 10, 2004. The Companyalso restated certain reorganization and merger costs associated with theMerger and presented the Company as a development stage company. Management ofthe Company believes that the accounting and disclosure decisions related tothe restatement are complex and require substantial judgment based oninterpretations of various accounting standards.

 

The Company’s management and Audit Committee have discussed the restatement issues with Johnson Miller & Co., CPA’s PC, its independent registered public accounting firm. After reviewing the restatement issues, the Company’s management and Audit Committee believe that, while the restatement is considered a significant deficiency in the Company’s disclosure controls and procedures, the primary circumstances that resulted in the restatement are unique to the complex accounting issues and interpretations made in connection with the Merger and occurred at a time when the Company had identified a significant deficiency in its disclosure controls and procedures relating to the lack of qualified accounting and financial management personnel. Subsequent to that time, the Company has hired a Controller and a Chief Financial Officer, both of whom have experience in accounting and financial reporting for public companies and are Certified Public Accountants. The Company believes that the corrective actions it has taken since the end of the period covered by this report, consisting of hiring qualified personnel, adequately address the significant deficiency associated with the restatement. Accordingly, management of the Company does not plan to implement any further changes to its disclosure controls and procedures with respect to the restatement.

 

**(b) Changes in Internal Controls overFinancial Reporting**

 

There were no changes in our internalcontrols that occurred during the most recent fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting. The Company’s independent registeredpublic accounting firm did not inform the Company of any material weaknesses ininternal control identified during the course of the audit of the Company’s ConsolidatedFinancial Statements.

 

**Item 8B. Other Information**

 

None.

 

# **PART III**

#  

**Item 9. Directors and Executive Officers****of the Registrant**

 

Information required by this item will be contained in our Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

 

**Item 10. Executive Compensation**

 

Information required by this item will be contained in our Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

 

**Item 11. Security Ownership of Certain Beneficial Owners and Managementand Related Stockholder Matters**

 

Information required by this item will be contained in our Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

 

**Item 12. CertainRelationships and Related Transactions**

 

Information required by this item will be contained in our Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

 

**Item 13. Exhibits**

 

(a) Exhibits.

 

44

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| 3.1    |   | Third Amended and Restated Articles of Incorporation of BPZ  Energy, Inc. (incorporated by reference to Exhibit 3.1 to BPZ  Energy, Inc.’s Registration Statement on Form SB-2 Amendment No. 2  (SEC File No. 333-122816)).                                                                                  |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 3.2    |   | Amended and Restated Bylaws incorporated by  reference to Exhibit 3.2 to the Company’s Form SB-2 (SEC  File No. 333-14497) filed on October 18, 1996).                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 3.3    |   | Amendment to Second Amended and Restated Articles of Incorporation of  Navidec, Inc. (incorporated by reference to Exhibit 3.4 to the  Company’s Form SB-2 (SEC File No. 333-122816) filed on  February 14, 2005).                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 4.1    |   | Form of Certificate for Common Stock of BPZ Energy, Inc., a  Colorado corporation (incorporated by reference to Exhibit 4.1 to the  Company’s Form SB-2 (SEC File No. 333-122816) filed on  February 14, 2005).                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.1   |   | Merger Agreement between Navidec, Inc. and BPZ, Inc. dated  July 8, 2004 (incorporated by reference to Exhibit 10.1 from the  Company’s Form 8-K filed July 13, 2004).                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.2   |   | Closing Agreement between Navidec, Inc. and BPZ, Inc. dated  September 8, 2004(incorporated by reference to Exhibit 10.1 from the  Company’s Form 8-K filed September 14, 2004).                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.3   |   | Business Consulting Agreement dated July 8, 2004 by and between  BPZ Energy, inc., a Colorado corporation, and Navidec Financial Services, Inc.,  a Colorado corporation (incorporated by reference to Exhibit 10.3 to the  Company’s Form SB-2 (SEC File No. 333-122816) filed on  February 14, 2005). |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.4   |   | License Contract from the Government of Peru for Block Z-1 dated  November 30, 2001 (incorporated by reference to Exhibit 10.5 to the  Company’s Form SB-2 (SEC File No. 333-122816) filed on  February 14, 2005).                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.5   |   | Amendment to License Contract from the Government of Peru for Block  Z-1 dated February 3, 2005 (incorporated by reference to Exhibit 10.5 of  the Company’s Annual Report on Form 10-KSB for the year ended  December 31, 2004).                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.6   |   | License Contract from the Government of Peru for Block XIX dated  December 12, 2003 (incorporated by reference to Exhibit 10.6 to the  Company’s Form SB-2 (SEC File No. 333-122816) filed on  February 14, 2005).                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.7   |   | Technical Evaluation Agreement from the Government of Peru for Area  VI dated December 12, 2003 (incorporated by reference to Exhibit 10.7 to  the Company’s Form SB-2 (SEC File No. 333-122816) filed on  February 14, 2005).                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.8   |   | Promotional Technical Evaluation Agreement from the Government of  Peru for Area XVI dated December 12, 2003 (incorporated by reference to  Exhibit 10.8 to the Company’s Form SB-2 (SEC File  No. 333-122816) filed on February 14, 2005).                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 16.1   |   | Letter from Hein & Associates, LLP (incorporated by  reference to Exhibit 16.1 from Navidec’s Form 8-K filed  November 18, 2004).                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 21.1   |   | Subsidiaries of the Small Business Issuer (filed herewith).                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 31.1   |   | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. (Filed herewith).                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 31.2   |   | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. (Filed herewith).                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 32.1   |   | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. (Filed herewith).                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                       |
| 32.2   |   | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. (Filed herewith).                                                                                                                                                        |

 

**Item 14. Principal Accountant Fees and Services**

 

Information required by this item will be contained in our Proxy Statement for the 2006 Annual Meeting of Stockholders, which is incorporated herein by reference.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 31, 2006.

 
|   | BPZ Energy, Inc. |
|--------|------------------|
|   |             |
|   | By:              | */s/  Manuel Pablo Zuniga-Pflucker* |   |
|   |             |  Manuel Pablo Zuniga-Pflucker |
|   |             | President  & Chief Executive Officer |

 

Pursuant to the requirements of the Securities Exchange Act of 1934,this report is signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated:

 
| By:      | /s/ MANUEL  PABLO ZÚÑIGA-PFLÜCKER   |   | By:    | /s/ RANDALL D. KEYS       |
|----------|----------------------------------------------------|--------|--------|---------------------------|
|     | Manuel Pablo  Zúñiga-Pflücker       |   |   | Randall D. Keys           |
| * * | *President, Chief Executive Officer and  Director* |   |   | *Chief Financial Officer* |
| Date:    | March 31, 2006                                     |   | Date:  | March 31, 2006            |
|     |                                               |   |   |                      |
|     |                                               |   |   |                      |
| By:      | /s/ FERNANDO  ZÚÑIGA Y RIVERO            |   | By:    | /s/ GORDON GRAY           |
|     | Dr. Fernando  Zúñiga y Rivero       |   |   | Gordon Gray               |
| * * | *Chairman of the Board*                            |   |   | *Director*                |
| Date:    | March 31, 2006                                     |   | Date:  | March 31, 2006            |
|     |                                               |   |   |                      |
|     |                                               |   |   |                      |
| By:      | /s/ JOHN J. LENDRUM III                            |   | By:    | /s/ E. BARGER MILLER III  |
|     | John J. Lendrum III                                |   |   | E. Barger Miller III      |
| * * | *Director*                                         |   |   | *Director*                |
| Date:    | March 31, 2006                                     |   | Date:  | March 31, 2006            |
|     |                                               |   |   |                      |
|     |                                               |   |   |                      |
| By:      | /s/ DENNIS G. STRAUCH                              |   |   |                      |
|     | Dennis G. Strauch                                  |   |   |                      |
| * * | *Director*                                         |   |   |                      |
| Date:    | March 31, 2006                                     |   |   |                      |

 

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