Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

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**Form 10-K**

 
| **x** | **ANNUAL REPORT PURSUANT  TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------------|

** **

**For the fiscal year ended December 31, 2008**

** **

**Or**

 
| **o** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|-------|----------------------------------------------------------------------------------------------------------|

** **

**For the transition period from              to              **

** **

**Commission File Number: 001-12697**

** **

**BPZ Resources, Inc.**

(Exact name ofregistrant as specified in its charter)

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

 

**580 Westlake Park Blvd., Suite 525Houston, Texas 77079**(Address of principalexecutive office)

** **

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

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

| **Title of  Each Class**    | ** ** | **Name of  Each Exchange on Which Registered** |
|-----------------------------|------------|------------------------------------------------|
| Common Stock, no  par value |       | New York Stock  Exchange Alternext U.S.        |

 

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

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.    Yes  o   No  x

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or15(d) of the Act.    Yes  o   No  x

 

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

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.     Yes  x   No  o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. See the definitions of “largeaccelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.

 
| Large accelerated filer  x     | Accelerated  filer                    o |
|------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------|
| Non-Accelerated filer   o | Smaller  reporting company   o                                                                                                    |

 

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

 

The number of shares ofCommon Stock held by non-affiliates as of June 30, 2008 was 52,728,868shares, all of one class of common stock, no par value, having an aggregatemarket value of approximately $1,550,228,719 based upon the closing price of registrant’scommon stock on such date of $29.40 per share as quoted on the New York StockExchange Alternext U.S. For purposes of the foregoing calculation, alldirectors, executive officers, and 5% beneficial owners have been deemedaffiliated.

 

As of February 23,2009 there were 93,054,150 shares of common stock, no par value, outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

** **

(1) Proxy Statement for 2009 Annual Meeting ofStockholders — Part III

 

 

 

** **

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**Tableof Contents**

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**TABLE OF CONTENTS**

 
| **PART I**                       | ** **                                                                                                         | ** ** |
|---------------------------------------|--------------------------------------------------------------------------------------------------------------------|------------|
|                                  |                                                                                                               |       |
| Item 1.                               | Business                                                                                                           | 3          |
| Item 1A.                              | Risk Factors                                                                                                       | 10         |
| Item 1B.                              | Unresolved  Staff Comments                                                                                         | 22         |
| Item 2.                               | Properties                                                                                                         | 23         |
| Item 3.                               | Legal Proceedings                                                                                                  | 28         |
| Item 4.                               | Submission of Matters to a Vote of  Security Holders                                                               | 28         |
|                                  |                                                                                                               |       |
| **PART II**                      | ** **                                                                                                         | ** ** |
| Item 5.                               | Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity Securities | 28         |
| Item 6.                               | Selected Financial Data                                                                                            | 31         |
| Item 7.                               | Management’s Discussion and Analysis of  Financial Conditions and Results of Operations                       | 32         |
| Item 7A.                              | Quantitative and Qualitative  Disclosures About Market Risk                                                        | 51         |
| Item 8.                               | Financial Statements and Supplementary  Data                                                                       | 53         |
| Item 9                                | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosures                             | 96         |
| Item 9A.                              | Controls and Procedures                                                                                            | 96         |
| Item 9B.                              | Other Information                                                                                                  | 97         |
|                                  |                                                                                                               |       |
| **PART III**                     | ** **                                                                                                         | ** ** |
| Item  10.                             | Directors,  Executive Officers and Corporate Governance                                                            | 98         |
| Item 11.                              | Executive Compensation                                                                                             | 98         |
| Item  12.                             | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                   | 98         |
| Item  13.                             | Certain  Relationships and Related Transactions, and Director Independence                                         | 98         |
| Item  14.                             | Principal  Accountant Fees and Services                                                                            | 98         |
|                                  |                                                                                                               |       |
| **PART IV**                      | ** **                                                                                                         | ** ** |
| Item 15.                              | Exhibits and Financial Statement  Schedules                                                                        | 99         |
|                                  |                                                                                                               |       |
| Glossary of Oil and Natural Gas Terms | 100                                                                                                                |
|                                  |                                                                                                               |       |
| Signatures                            | 102                                                                                                                |

 

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**PART I**

 

*BPZResources, Inc. cautions that this document contains forward-lookingstatements within the meaning of the Private Securities Litigation Reform Actof 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. All statements, other thanstatements of historical facts, included in or incorporated by reference intothis Form 10-K which address activities, events or developments which theCompany expects, believes or anticipates will or may occur in the future areforward-looking statements. The words “may,” “will,” “should,” “could,” would,”“expects,” “plans,” “anticipates,” “intends,” “believes,” “estimates,” “projects,”“predicts,” “potential” and similar expressions are also intended to identifyforward-looking statements. These statements are based on certain assumptionsand analyses made by the management of BPZ in light of its experience and itsperception of historical trends, current conditions and expected futuredevelopments as well as other factors it believes are appropriate under thecircumstances. The Company cautions the reader that these forward-lookingstatements are subject to risks and uncertainties, many of which are beyond itscontrol, that could cause actual events or results to differ materially fromthose expressed or implied by the statements. See Item 1A. — “Risk Factors”included in this Form 10-K.*

* *

*Unlessthe context requires otherwise, references in this Annual Report on Form 10-Kto “BPZ”“we”, “us”, “our” and the “Company” refer to BPZ Resources, Inc.,and its consolidated subsidiaries.*

* *

**ITEM 1. BUSINESS**

 

**Overview**

** **

BPZ Resources, Inc., a Texas corporation, is based in Houston,Texas with offices in Lima, Peru and Quito, Ecuador. We are focused on theexploration, development and production of oil and natural gas in Peru andEcuador. We also intend to utilize part of our planned future natural gasproduction as a supply source for the complementary development of a Companyowned gas-fired power generation facility in Peru.

 

We maintain a subsidiary registered in Peruthrough our wholly-owned subsidiary BPZ Energy, LLC, a Texas limitedliability company, formerly BPZ Energy, Inc. (“BPZ — Texas”) and itssubsidiary BPZ Energy International Holdings, L.P., a British Virgin Islandslimited partnership. Currently, we have exclusive rights and license agreementsfor oil and gas exploration and production covering a total of approximately2.4 million acres, in four blocks, in northwest Peru. Our license contractscover 100% ownership of Block Z-1 (739,205 acres), Block XIX (472,860 acres),Block XXII (948,000 acres) and Block XXIII (248,000 acres). The Block Z-1contract was signed in November 2001, the Block XIX contract was signed inDecember 2003 and Blocks XXII and XXIII contracts were signed in November 2007.Our license contracts provide for an initial exploration period of seven andpotentially up to thirteen years for Block Z-1 and seven and potentially up tenyears for Blocks XIX, XXII and XXIII. In addition, they require that we conductspecified activities on the Blocks during this period. If the explorationactivities are successful, our total contract term can extend up to 30 years foroil exploration and production and up to 40 years for gas exploration andproduction. In the event a Block contains both oil and gas, as is the case inour Block Z-1, the 40 year term applies to oil exploration and production aswell.

 

Additionally, through our wholly-ownedsubsidiary, SMC Ecuador Inc., a Delaware corporation, and its registered branchin Ecuador, we own a 10% non-operated working interest in an oil and gasproducing property, Block 2, located in the southwest region of Ecuador (the “SantaElena Property”). The license agreement covering the property extends through May 2016.

 

We are in the initial stages of developingour oil and natural gas reserves and have begun producing and selling oil fromthe CX11 platform in the Corvina field of Block Z-1 under an extended welltesting program. Additionally our activities in Peru include analysis andevaluation of technical data on our Blocks, preparation of the developmentplans for the Blocks, including detailed engineering and design of the power plantand gas processing facilities, refurbishment of and designs for platforms tocarry our drilling campaigns in the Corvina and Albacora fields in Block Z-1,procuring machinery and equipment for an extended drilling campaign, obtainingall necessary environmental and operating permits, bringing additionalproduction on-line and securing the required capital and financing to conductthe current plan of operation.

 

At December 31, 2008, we had estimated netproved oil reserves of 17.2**MMBbls all of which were in the Corvina field inBlock Z-1 located offshore northwestPeru. Of our total proved reserves, 4.2 MMBbls (25%) are classified asproved developed producing reserves and approximately 12.9 MMBbls (75%) are classified as proved undevelopedreserves. See “Supplemental Oil and Gas Disclosures (Unaudited)” to ourconsolidated financial statements provided herein for further information.

 

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We have determined our reporting structureprovides for only one operating segment as we only operate in Peru and haveonly one customer for our production. Information regarding ouroperating segment including our revenues and long-lived assets can be found inthe footnotes to our consolidated financial statements starting on page 53of this Annual Report on Form 10-K.

 

**Our Business Plan**

 

Our businessplan is to enhance shareholder value primarily through our unique knowledge ofour targeted areas in Peru and leveraging management’s relationship with thelocal suppliers and regulatory authorities to effectively and efficientlyoperate the oil and gas exploration and development process in Peru.

 

Our focus isto re-appraise and develop properties in northwest Peru that have been exploredby other companies and have reservoirs that appear to contain commerciallyproductive quantities of oil and gas, as well as other areas that havegeological formations that we believe potentially contain commercial amounts ofhydrocarbons.

 

Two of thefour blocks which we currently have exclusive rights and license agreements foroil and gas exploration and production, contain structures which were drilledby previous operators who encountered hydrocarbons. However, at the time thewells were drilled, the operators did not consider it economically feasible toproduce the hydrocarbons in the fields.  The Company, having found oil inits first well in the Corvina field in offshore Block Z-1 in 2007, has turnedits focus to development of the proved reserves in Corvina, as well as tore-developing the Albacora oil field which has a platform in place with threeshut in oil wells drilled and produced by Belco in the 1980’s.

 

In addition,our business plan includes a gas-to-power project, which entails theinstallation of a 10-mile gas pipe from the CX-11 platform to shore,construction of gas process facilities and an approximately 135 megawatt (“MW”)simple cycle electric generating plant. The proposed power plant site islocated adjacent to an existing substation and power transmission lines which,with certain upgrades, are expected to be capable of handling up to 360 MW ofpower.

 

Our managementteam has extensive engineering, geological, geophysical, technical andoperational experience. Additionally our management team has extensiveknowledge of international oil and gas operations throughout Latin America andin particular, Peru.

 

We willconcentrate our energies on areas we believe contain proven oil and gasreserves that can be economically developed and produced in commercialquantities and leverage our knowledge of oil and gas operations in the areas weoperate.  We believe this strategy will allow us to develop the oil andgas effectively and efficiently to enhance the profitability of the Company,and thus increase shareholder value.

 

**Reincorporation,Name Change and Internal Restructuring**

** **

On October 11, 2007, BPZ Energy, Inc.,a Colorado corporation, formerly named Navidec, Inc., completed a reincorporationfrom Colorado to the State of Texas pursuant to the Plan of Conversion asapproved by the shareholders at the 2007 annual meeting of shareholders held onAugust 17, 2007. The related filings with the Secretary of State of Texasalso included a change of the Company’s name from BPZ Energy, Inc. to BPZResources Inc., in connection with an ongoing review of certain internalreorganization matters related to our international tax planning and corporatestructure. The Company continues to do business under the name BPZ Energy inits regular business operations.

 

No changes to the members of the Board ofDirectors, the management, or the operations of the Company were made inconnection with the conversion from a Colorado corporation to a Texas corporation.The Company remains as the same business entity following the reincorporationto Texas, with all of the assets, rights, privileges and powers of, and allproperty owned by, all debts due to, as well as any causes of action belongingto the predecessor Colorado entity. As part of the reincorporation, a newCertificate of Formation and new Bylaws were adopted, which now govern therights of holders of the Company’s common stock. At the effective time of thereincorporation, each outstanding share of the Colorado entity prior to thereincorporation was automatically converted into one share of the Texas entity.

 

**AvailableInformation**

** **

The Company maintains awebsite (http://www.bpzenergy.com), on which we make available, free of charge,all of the Company’s above mentioned filings with the Security and ExchangeCommission (“SEC” or “Commission”), including Forms 3, 4 and 5 filed withrespect to our equity securities under Section 16(a) of theSecurities Act of 1934. These filings will be available as soon as reasonablypracticable after we electronically file such material with, or furnish it to,the SEC.

** **

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**Our Competition**

** **

Intense competition exists in the oil and gasindustry with respect to the acquisition of producing properties, undevelopedacreage, and rights to explore for such properties. Many major and independentoil and gas companies actively pursue and bid for the mineral rights ofdesirable properties, and many companies have been actively engaged inacquiring oil and gas properties specifically in Peru and Ecuador.

 

We believe our efforts in and uniqueknowledge of our targeted areas have given us a competitive advantage in Peru,and to a lesser extent, Ecuador. Although un-leased tracts exist within ourtarget area, we believe these properties may be less attractive to othercompanies because it will be difficult for them to obtain a significant amountof contiguous mineral acres. This results in part from our significant holdingsin the vicinity of these un-leased tracts. However, increased demand forlicense contracts in surrounding areas may impact our ability to expand andgrow in the future, particularly because many of our competitors havesubstantially greater financial and other resources, in addition to better namerecognition and longer operating histories. As a result, we may not be able tocompete successfully to acquire additional oil and gas properties in desirablelocations.

 

Intense competition for access to drillingand other contract services and experienced technical and operating personnelneeded to drill and complete wells also exists in the oil and gas industry.Competition for drilling and contract services in our target area exists andmay affect our plan of operation. We are adjusting our operating plans andtimelines to adapt to this changing environment. However, increasing futuredemand for drillers and contractors may limit our ability to execute in atimely manner and may negatively impact our ability to grow.

 

**Customers**

 

To date, all of our sales of oil in Peru havebeen made under a short-term contract to the Peruvian national oil company,Petroperu. However, we believe that the loss of our sole customer wouldnot materially impact our business, because we could readily find otherpurchasers for our oil production.

 

Subsequentto December 31, 2008, our wholly-owned subsidiary, BPZ Exploración &Producción S.R.L., entered into a long-term oil supply agreement withPetroperu. Under the terms of the contract, we agree to sell, and Petroperuagrees to purchase, all of our crude oil production originating from theCorvina oilfield in Block Z-1. The contract term is for approximately sevenyears or until 17 million barrels of crude oil has been delivered to thePetroperu refinery located in Talara, whichever comes first. The price perbarrel of oil under the agreement is determined on the date of delivery basedon the previous 15-day average of crude oil prices consisting of Forties, Oman,and Suez blend, as quoted in the Spot Crude Prices Assessment published inPlatt’s Crude Oilgram Price Report, minus $1 per barrel and other customarypurchase price adjustments.

 

**RegulationImpacting Our Business**

** **

***General***

*** ***

Various aspects of our oil and natural gasoperations are currently or will be subject to various foreign laws andgovernmental regulations. These regulations may be changed from time to time inresponse to economic or political conditions. Although we believe ouroperations are and will be in substantial compliance with existing legislationand requirements of governmental bodies, our ability to conduct continuedoperations is subject to satisfying applicable regulatory and permitting controls.Our principals have many collective decades of experience in dealing directlywith the Peruvian government on energy projects. Therefore we believe we are ina unique position to understand and comply with local rules andregulations. However, our current permits and authorizations as well as ourability to obtain future permits and authorizations may, over time, besusceptible to increased scrutiny and greater complexity which could result inincreased costs or delays in receiving appropriate authorizations.

 

***Peru***

 

***Peruvian hydrocarbon legislation.***Peru’shydrocarbon legislation, which includes the Organic Hydrocarbon Law No. 26221and the regulations thereunder (the “Organic Hydrocarbon Law”), governs ouroperations in Peru. This legislation covers the entire range of petroleumoperations, defines the roles of Peruvian government agencies which regulateand interact with the oil and gas industry, requires that investments in thepetroleum sector be undertaken solely by private investors (either national orforeign), and provides for the promotion of the development of hydrocarbonactivities based on free competition and free access to all economicactivities. This regulation provides that pipeline transportation and naturalgas distribution 

 

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must be handled via contracts with the appropriate governmentalauthorities. All other petroleum activities are to be freely operated and aresubject to local and international safety and environment standards.

 

Under this legal system, Peru is the owner ofthe hydrocarbons located below the surface in its national territory. However,Peru has given the ownership right to extracted hydrocarbons to Perupetro, astate company responsible for promoting and overseeing the investment ofhydrocarbon exploration and exploitation activities in Peru. Perupetro isempowered to enter into contracts for the exploration and exploitation ofhydrocarbons on behalf of Peru, the nature of which are described furtherbelow. 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 sectorsand supervising compliance with such policies and rules. Within the Ministry ofEnergy and Mines,  OrganismoSupervisor de la Inversión en Energía y Mineria (“OSINERGMIN”) is theagency charged with economic and technical supervision. We are subject to thelaws and regulations of all of these entities and agencies.

 

Perupetro generally enters into eitherlicense contracts or service contracts for hydrocarbon exploration andexploitation. Peru’s laws also allow for other contract models, but theinvestor must propose contract terms compatible with Peru’s interests. We onlyoperate under license contracts and do not foresee operating under any servicescontracts. A company must be qualified by Perupetro to enter into hydrocarbonexploration and exploitation contracts in Peru. In order to qualify, thecompany must meet the standards under the Regulations Governing theQualifications of Oil Companies. These qualifications generally require thecompany to have the technical, legal, economic and financial capacity to complywith all obligations it will assume under the contract based on thecharacteristics of the area requested, the possible investments and theenvironmental protection rules governing the performance of itsoperations. When a contractor is a foreign investor, it is expected toincorporate a subsidiary company or registered branch in accordance with Peru’slaws and appoint representatives who will interact with Perupetro.

 

Perupetro reviews the qualification for eachcontract signed by a company. Additionally, the qualification for foreigncompanies is granted in favor of the home office or limited liability company,which is jointly and severally liable at all times for the technical, legal,economic and financial capacity of its Peruvian subsidiary or branch. BPZEnergy, LLC (Texas) and its corresponding subsidiary in Peru has been qualifiedby Perupetro with respect to our current contracts as required by current regulation.

 

When operating under a license contract, thelicensee is the owner of the hydrocarbons extracted from the contract areaduring the performance of operations, and pays royalties which are collected byPerupetro. The licensee can market the hydrocarbons in any manner whatsoever,subject to a limitation in the case of natural emergencies where the lawstipulates such manner.

 

Licensees are obligated to submit quarterlyreports to the Hydrocarbons Bureau (“Direccion General de Hidrocarburos”).Licensees must also submit a monthly economic report to the Central Bank ofPeru (“Banco Central de Reserva”). These reports are generally combined anddelivered together with other operating reports required to be submitted toPerupetro.

 

The duration of the license contracts isbased on the nature of the hydrocarbons discovered. The contract duration forcrude oil is thirty years, while the contract duration for natural gas andcondensates is forty years. The periods commence on an agreed date and aredetermined based on location of the contract area, season of the year in whichexploration commences, and other similar factors. Contracts typically includean exploration phase and an exploitation phase, unless the contract is solelyan exploitation contract. Within the contract term, seven years is allotted toexploration, with the possibility of up to a three year extension. A potentialdeferment period for a maximum of ten years is also available if certainfactors recognized by law delay the economic viability of a discovery, such aslack of transportation facilities or lack of a market. The exploration phase isgenerally divided into several 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 evaluationagreements. These agreements give the contractor the right to conduct technicalevaluations of the areas under such agreements and to enter into licensecontracts if the evaluations indicate the potential for profitable operations.The technical evaluation agreement is generally for a period of twenty-fourmonths, depending upon the volume and nature of the work to be carried out.

 

We currently have four license contracts. Asof February 23, 2009, we believe we were in compliance with all of thematerial requirements of each such contract. We have executed certain lettersof guaranty in favor of Perupetro to insure our 

 

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performance under the licensecontracts. At December 31, 2008, we had $5.3 million in bonds posted atvarious dates, to secure our obligation under the license contracts for BlockXIX, Z-1, XXII and XXIII and a drilling service agreement. The license contractbonds are partially secured by the deposit of restricted cash with the financialinstitutions which issued the bonds in the amount of $2.9 million. Additionallywe have $2.2 million of restricted cash to collateralize insurance bonds forimport duties related to the floating production, storage and offloadingfacility (“FPSO”) and transporttanker. Should we fail to fulfill our obligations under any of ourlicense contracts without technical justification or other good cause,Perupetro and/or our service provider could seek recourse to the bond orterminate the license and/or the service contract.

 

***Peruvian fiscal regime.***Peru’sfiscal regime determines the levels of the government’s entitlement frompetroleum activities. This regime is subject to change, which could negativelyimpact our business.

 

License contracts are subject to royaltypayments, which are usually a fixed percentage of the actual production sold.The taxing regulations stipulate a minimum royalty payment of five percentincreasing incrementally to a maximum of twenty percent based on production.However, the bidding company can choose to increase the royalty payoutpercentage to win a successful bid for a block.

 

The Organic Hydrocarbon Law and theRegulations Governing the Tax Stability Guaranty and Other Tax Rules ofthe Organic Hydrocarbon Law provide that the tax regime in force on the date ofsigning a contract will remain unchanged during the term of the contract.Therefore, any change to the tax regime, which results in either an increase ordecrease in the tax burden, will not affect the operator.

 

During the exploration phase, operators areexempt from import duties and other forms of taxation applicable to goodsintended for exploration activities. Exemptions are withdrawn at the productionphase, but exceptions are made in certain instances, and the operator may beentitled to import goods tax-free for an additional two-year period.

 

Taxable income is determined by deductingallowable operating and administrative expenses, including royalty payments.Income tax is levied on the income of the operator based upon the legalcorporate tax rate in effect at the date the contract was signed. Operatorsengaged in the exploration and production of crude oil, natural gas andcondensates must determine their taxable income separately for each licensecontract under which they operate. Where a contractor carries out theseactivities under different individual license contracts, it may offset itsearnings before income tax under one license contract with losses under anotherlicense contract, as long as the contract with the loss is in the commercialproduction phase or has been relinquished, for purposes of determining thecorporate income tax provided that the individual license contracts are held bythe same company as Peruvian tax law does not permit filing a consolidated taxreturn for related companies.  However,under no circumstances can the investment in the producing property beamortized for tax purposes over a period of five years unless the company isunder the commercial stage of production.

 

***Peruvian labor and safety legislation.***Ouroperations in Peru are also subject to the Unified Labor Law, which governs thelabor force in the petroleum sector. In addition, the Organic Hydrocarbon Lawand related Safety Regulations for the Petroleum Industry also regulate thesafety and health of workers involved in the development of hydrocarbonactivities. All entities engaged in the performance of activities related tothe petroleum industry must provide the General Hydrocarbons Bureau on asemi-annual basis with the list of their personnel, indicating theirnationality, specialty and position. These entities must also permanently traintheir workers on the application of safety measures in the operations, andcontrol of disasters and emergencies. Each entity must keep detailed records ofall accidents that occur in its operations and report all accidents to the OSINERGMIN. The regulations alsocontain provisions on accident prevention and personnel health and safety,which in turn include rules on living conditions, sanitary facilities,water quality at workplaces, medical assistance and first-aid services.Provisions specifically related to the exploration phase, which is our currentphase of operations, are also contained in the regulations and include safetymeasures in camps, medical assistance, food conditions, and handling ofexplosives. Additional safety regulations may also apply as we expand anddevelop our operations.

 

The Constitution of Peru and LegislativeDecree Nos. 677 and 892 gives employees working in private companies engaged inactivities generating income classified as third category income by the IncomeTax Law the right to share in the company’s profits. This profit sharing iscarried out through the distribution by the company of a percentage of the annualincome before tax. According to Article 3 of the United NationsInternational Standard Industrial Classification, BPZ Resources, Inc.’stax category is classified under the “mining companies” section, which sets therate at 8%. However, in Peru the Hydrocarbons’ Law states, and the SupremeCourt ruled, that hydrocarbons are not related to mining activities.Hydrocarbons are included under “Companies Performing other Activities” thusOil and Gas Companies pay profit sharing at a rate of 5%. The benefit grantedby the law to employees is calculated on the basis of the “net income subjectto taxation” and not on the net business or accounting income of companies. “Taxableincome” is obtained after deducting from total revenues subject to income tax,the expenses required to produce them or maintain the source thereof.

 

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The following factors are taken into accountregarding the profit sharing system: (1) calculation of profits to bedistributed to each employee is based on two criteria (a) the number ofdays actually worked by each employee, and (b) in proportion to theremunerations of each employee; (2) number of days actually worked(including leave of absence, temporary shutdown of the workplace, and days notworked due to improper suspension by the employer); (3) remuneration (thefull amount received by the employee for his services); (4) maximum profitshare limit of 18 monthly remunerations; (5) remainder between the maximumpercentage of company profits to be distributed and the maximum limit of thepercentage corresponding to all employees; (6) timing of distributionsshould be made within thirty calendar days after expiration of the term for thefiling of the Annual Income Tax Return; (7) default interest; (8) evidenceof settlement of profits; and (9) deductible expenses.

 

***Peruvian electric power legislation.***Ourbusiness plan envisions the generation of electricity and the sale of suchelectric power in Peru. The basic laws in Peru governing electric power, whichwill apply to our future operations, are the Law of Electric Power Concessionsand the Regulations for the Environmental Protection of Electric PowerActivities, the corresponding regulations for each, as well as additionalrelated laws and regulations, including all legislation regarding ElectricPower Tariffs and all regulations and technical norms created by the NationalCommission of Electric Power Tariffs.

 

***Peruvian environmental regulation.***Ouroperations are subject to numerous and frequently changing laws and regulationsgoverning the discharge of materials into the environment or otherwise relatingto environmental protection. Peru has enacted specific environmentalregulations applicable to hydrocarbon industry. The Code on the Environment andthe Natural Resources establishes a framework within which all specific lawsand regulations applicable to each sector of the economy are to be developed.These laws and regulations are designed to ensure a 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 Energyis charged with the responsibility of issuing the applicable standards.OSINERGMIN is responsible for ensuring compliance with applicable environmentalrules covering hydrocarbon activities.

 

The Organic Hydrocarbon Law also addressesthe environmental regulatory regime in Peru. The law originally prohibited anymining or extractive operations within certain areas designated for protection.It was, however, subsequently modified to enable investors to prospect forhydrocarbons within protected areas, provided there is compliance with severalobligations. We must comply with these obligations as we conduct our businesson an ongoing basis. The Environmental Regulations for Hydrocarbon Activitiesprovide that companies participating in the implementation of projects,performance of work and operation of facilities related to hydrocarbonactivities, are responsible for the emission, discharge and disposal of wastesinto the environment. Companies must annually file a report corresponding tothe previous year describing the company’s compliance with the environmentallegislation in force.

 

Companies involved in hydrocarbon activitiesmust also prepare and file an Environmental Impact Study (“EIS”) with theGeneral Hydrocarbons Bureau, which is part of the Ministry of Energy and Mines,in order for the relevant activities to comply with the maximum permissibleemission limits set forth by the Ministry of Energy and Mines. An EIS must beprepared for each project to be carried out. All of these proposals must beapproved by the General Environmental Bureau, which is also part of theMinistry of Energy and Mines.

 

In addition, any party responsible for hydrocarbonactivities must file an “Oil Spill and Emergency Contingency Plan” with theGeneral Hydrocarbons Bureau. The plan must be updated at least once a year andmust contain information regarding the measures to be taken in the event ofspills, explosions, fires, accidents, evacuation, etc. It must also containinformation on the procedures, personnel and equipment required to be used andprocedures to be followed to establish uninterrupted communication between thepersonnel, the government representatives, the General Hydrocarbons Bureau andother State entities.

 

Peru has recently enacted amendments to itsenvironmental law, imposing substantial restrictions on the use of naturalresources, interference with the natural environment, location of facilities,handling and storage of hydrocarbons, use of radioactive material, disposal ofwaste, emission of noise and other activities. Additionally, the laws requiremonitoring and reporting obligations in the event of any spillage orunregulated discharge of hydrocarbons.

 

Any failure to comply with environmentalprotection rules, the import of contaminated products, or failure to keep amonitoring register or send reports to the General Hydrocarbons Bureau in atimely fashion, could subject the company to fines. In addition, the GeneralHydrocarbons Bureau may consider imposing a prohibition or restriction of therelevant activity, an obligation to compensate the aggrieved parties and/or anobligation to immediately restore the area. The company responsible for anydefault can also be subject to a suspension of operations for a term of one,two or three months, or 

 

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indefinitely. Furthermore, anycontract signed with the Peruvian government, the implementation of whichjeopardizes or endangers the protection or conservation of protected naturalareas, can be terminated.

 

We are subject to all Peruvian environmentalregulations applicable to the petroleum industry now in existence and thoseexisting in the future. For example, we are required to obtain an environmentalpermit or approval from the government in Peru prior to conducting any seismicoperations, drilling a well or constructing a pipeline in Peruvian territoryincluding the waters offshore Peru where we intend to conduct oil and gasoperations. The enactment and enforcement of environmental laws and regulationsin Peru is relatively new. We are therefore uncertain how Peruvian authoritieswill enforce and supervise environmental compliance and standards. Further, wecannot predict any future regulation or the cost associated with futurecompliance.

 

Although we believe our operations are insubstantial compliance with existing environmental requirements, our ability toconduct continued operations is subject to satisfying applicable regulations.Our current permits and authorizations and ability to obtain future permits andauthorizations may be susceptible, on a going forward basis, to increasedscrutiny, greater complexity resulting in increased costs, or delays inreceiving appropriate authorizations. In particular, we may in the futureexperience delays in obtaining permits and authorizations in Peru necessary forour operations.

 

***Compliance with Existing Legislation in Peru***

 

Although we believe our operations are andwill be in substantial compliance with existing legislation and requirements ofPeruvian governmental bodies, our ability to conduct continued operations issubject to satisfying applicable regulatory and permitting controls. As notedabove, our principals have many collective decades of experience in dealingdirectly with the Peruvian government on energy projects. Therefore, we believewe are in a good position to understand and comply with local rules andregulations.

 

***Ecuador***

 

SMC Ecuador, Inc., our wholly-ownedsubsidiary, has held its 10% non-operating interest in the Santa Elena oilfields since 1997. We acquired all of the common stock of SMC Ecuador Inc. in2004. As a non-operator, we are not directly subject to the laws andregulations of Ecuador covering the oil and gas industry and the environment.However, if we begin operating activities in Ecuador, we will be directlysubject to such laws and regulations.

 

**EnvironmentalCompliance and Risks**

** **

As an owner or lessee and operator of oil andgas properties in South America, in particular Peru, we are subject to variousnational, state and local laws and regulations relating to discharge of materialsinto, and protection of, the environment. These laws and regulations may, amongother things, impose liability on the contractor under an oil and gas licenseagreement for the cost of pollution clean-up resulting from operations, subjectthe contractor to liability for pollution damages, and require suspension orcessation of operations in affected areas.

 

In addition to certain pollution coveragerelated to our surface facilities, we also maintain insurance coverage for seepage andpollution, cleanup and contamination from our wells. Regardless, no suchcoverage can insure us fully against all environmental risks. We are not awareof any environmental claims which would have a material impact upon ourfinancial position or results of operations.

 

We will continue our efforts to comply withthese requirements, which we believe are necessary to maintain successfullong-term operations in the oil and gas industry. As part of this effort wehave established guidelines for continuing compliance with environmental lawsand regulations. In order to carry out our plan of operation, we are requiredto conduct environmental impact studies and obtain environmental approvals foroperations. We have engaged outside consultants to perform these studies andassist us in obtaining necessary approvals. Our cost for these studies andassistance related to the Block Z-1 Corvina and Albacora fields and Block XIX forthe years ended December 31, 2008, 2007 and 2006 were approximately $0.5million, $0.3 million and $0.5 million, respectively. We are currentlyassessing what studies are necessary and the associated cost estimate forBlocks XXII and XXIII.

 

In January, 2008 the T/V SUPE (“Supe”), asmall tanker that one of our primary marine transportation contractors was charteringfrom the Peruvian Navy’s commercial branch sank after catching fire. The 7,500barrel capacity Supe, which was moored near the Corvina CX-11 platform and wasbeing used to store oil produced from Corvina’s CX11-21XD and 14D wells, caughtfire and later sank approximately one mile from the platform. At the time ofthe incident the Supe 

 

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contained approximately 1,300barrels of oil, which burned in the fire. Subsequent assessments showed thatenvironmental issues were adequately controlled.

 

There was no significant or material damageto our platform, barges, drilling and well testing equipment, or other facilitieswe own and the damage was limited mostly to the Supe. We contracted theservices of Clean Caribbean and Americas (“CCA”) to conduct an environmentaldamage assessment in and around the area surrounding the incident. CCAconcluded that the majority of the crude oil contained in the Navy tanker wasconsumed during the fire subsequent to the explosion. This was confirmed afterdivers inspected the sunken tanker, which is resting 200 feet underwater, andreported that no crude oil was detected in any of the tanks. Our environmentalconsultants, as well as several independent organizations, conducted additionallab tests on seawater and marine life within the potentially affected area andthese lab test results indicated no contamination related to the incident. In March 2008,OSINERGMIN, the government regulatory agency in Peru responsible formonitoring industrial safety, cleared the Company to resume operations at theCX-11 platform in the offshore Z-1 Block in northwest Peru. We have notreceived any additional requests from any regulatory agency requiring us toperform additional services related to this incident in order for us to be incompliance with environmental regulation.

 

We do not believe compliance with national,state or local provisions regulating the discharge of materials into theenvironment, or otherwise relating to the protection of the environment, willhave a material adverse effect upon the capital expenditures, earnings orcompetitive position of the Company or its subsidiaries. However, there is noassurance that changes in or additions to laws or regulations regarding theprotection of the environment will not have such an impact.

 

**OperationalHazards and Insurance**

** **

Our operations are subject to the usualhazards incidental to the drilling and production of oil and gas, such asblowouts, cratering, explosions, uncontrollable flows of oil, gas or wellfluids, fires, pollution, releases of toxic gas and other environmental hazardsand risks. These hazards can cause personal injury and loss of life, severedamage to and destruction of property and equipment, pollution or environmentaldamage and suspension of operations.

 

As is common in the oil and natural gasindustry, we do not insure fully against all risks associated with our businesseither because such insurance is not available or because premium costs areconsidered prohibitive. We currently have insurance coverage which we believeis adequate for our current stage of operations based on management’sassessment. Such insurance may not cover every potential risk associated withthe drilling, production and processing of oil and gas. In particular, coverageis not obtainable for all types of environmental hazards. Additionally, theoccurrence of a significant adverse event, the risks of which are not fullycovered by our insurance policy, could have a material adverse effect on ourfinancial condition and results of operations. Moreover, no assurance can begiven that we will be able to maintain adequate insurance or increase currentcoverage amounts at rates we consider reasonable.

 

**Research andDevelopment**

** **

We seek to use advanced technologies in theevaluation of our oil and gas properties and new opportunities. We generally donot develop such technologies internally, but our technical team works withoutside vendors to test and utilize these technologies to the fullest practicalextent, particularly in the application of geophysical and explorationsoftware. In certain cases, our collaboration has aided the development ofthese technologies. We do not believe we have incurred any quantifiableincremental costs in connection with research and development activities.

 

**Employees**

** **

As of December 31, 2008, we employed 27full-time employees (of which four are executive officers) in our Houstonoffice and 145 full-time employees (of which one is an executive officer) inour Lima, Peru office. We had three full-time employees in the Quito, Ecuadoroffice. BPZ believes that its relationship with its employees is satisfactory.None of our employees are currently represented by a union.

 

**ITEM 1A. RISK FACTORS**

** **

**Risks Relating to the Oil and Natural GasIndustry, the Power Industry, and Our Business.**

 

***We have a limitedoperating history and have only engaged in start-up and development activities.*** We are in theinitial stages of developing our oil and natural gas reserves and have recentlybegun producing and selling oil from our recent discoveries under an extendedwell test program.  We are also subject to all of the risks inherent inattempting to expand a relatively new business venture. Such risks include, butare not limited to, the possible inability to profitably operate our 

 

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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. Accordingly, weare subject to the risk that because of these factors and other generalbusiness risks noted throughout these “Risk Factors,” we may, in particular,not be able to profitably execute our plan of operation.

 

***We have not beenprofitable since we commenced operations and have a significant working capitaldeficit***. To date we have had limited revenue and limitedearnings from operations. As of December 31, 2008, we had a workingcapital deficit of approximately $30 million, and we may incur working capitaldeficits in the future. We cannot provide any assurance that we will beprofitable in the future or that we will be able to generate cash fromoperations or financings to fund working capital deficits.

 

***We must comply withPeruvian legal and regulatory requirements to be able to produce and sell oilbeyond the period of the current well test program.*** Our currentwell test program in the Corvina Field will likely end no later than May 31, 2010. In particular, we are required to meet certain environmental and technical requirementsbefore the end of the well test program in order to continue with commercialsales.  If we fail to meet these requirements before the end of the welltest period, we could be required to cease production and discontinuecommercial sales, which would have a materially adverse impact on our financialcondition, our operations and our ability to execute our business plan.

 

***As of December 31,2008, approximately 75% of our estimated net proved reserves were undeveloped.***  ***There can be no assurance that all of thesereserves will ultimately be developed or produced. *** We ownrights to oil and gas properties that have limited or no development. There areno 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.

 

Recovery of undevelopedreserves requires significant capital expenditures and successful drillingoperations.  The reserve data assumes that we will make significantcapital expenditures to develop our reserves.  We have prepared estimatesof our natural gas and oil reserves and the costs associated with thesereserves in accordance with industry standards.  However, the estimatedcosts may not be accurate, development may not occur as scheduled, or theactual results may not be as estimated.  We may not have or be able toobtain the capital we need to develop these proved reserves.

 

***We require additionalfinancing for the exploration and development of our foreign oil and gasproperties and the construction of our proposed power generation facility,pipeline and gas processing facility.*** Since the merger withNavidec, Inc. (“Navidec”) on September 10, 2004 (the “Merger”), wehave funded our operations with the net proceeds of approximately $197 millionin various private placements of our common stock, $15.5 million in convertibledebt financing from the International Finance Corporation (“IFC”), and $15.0million in a reserve-based lending facility with IFC. We have recently begun togenerate revenues from operations. With these funds we have begun to implementour plans to develop our existing oil and gas properties, but we will needsignificant additional financing to fully implement our plan of operation. Ifwe are unable to timely obtain adequate funds to finance our exploration anddevelopment, our ability to develop our oil and natural gas reserves may belimited 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, which could, in turn, limit ourability to repay our debts. Inability to timely obtain funds also could causeus to delay, scale back or abandon our plans for construction of our power generationfacility, pipelines, and gas processing facility.

 

 Future amountsrequired to fund our foreign activities may be obtained through additionalequity and debt financing, joint venture arrangements, the sale of oil and gasinterests, and/or future cash flows from operations. However, adequate fundsmay not be available when needed or may not be available on favorable terms.The exact nature and terms of such funding sources are unknown at this time,and there can be no assurance that we will obtain such funding or have adequatefunding available to finance our future operations.

 

***Any failure to meet ourdebt obligations or the occurrence of a continuing default under our debtfacility would adversely affect our business and financial condition.***  Throughour subsidiaries BPZ Exploración & Producción S.R.L. and BPZ MarinePeru S.R.L., as borrowers, we entered into a $15.0 million senior revolvingdebt facility with IFC in August 2008, which funded in October 2008. Thisis the first tranche of the proposed overall debt package with the IFC, and acommercial bank, which is expected to be a total of approximately $90.0 milliononce the second tranche has been finalized with the commercial bank.  Oncethe second tranche is closed, we expect the initial available borrowingcapacity to be approximately $60.0 million, inclusive of the $15.0 millionalready closed and funded by the IFC. The current facility (and the additionalsenior debt, when and if closed) will be secured by the current proved oilreserves in our Corvina field in Block Z-1.

 

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The debt facility providesfor events of default customary for agreements of this type, including, amongother things:

 
| · | payment breaches under any of the finance  documents for the first and second tranche of the senior debt;                                                                                                                                                                    |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                         |
| · | failure to comply with obligations under the  finance documents;                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                         |
| · | representation and warranty breaches;                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                         |
| · | expropriation of the assets, business or  operations of any borrower;                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                         |
| · | insolvencies of any borrower;                                                                                                                                                                                                                                                |
|   |                                                                                                                                                                                                                                                                         |
| · | certain attachments against the assets of any  borrower;                                                                                                                                                                                                                     |
|   |                                                                                                                                                                                                                                                                         |
| · | abandonment or extended business interruption of  the Corvina Field or certain other petroleum assets for a period over 100  consecutive days or an aggregate of 120 days in any twelve month period;                                                                        |
|   |                                                                                                                                                                                                                                                                         |
| · | failure to maintain certain authorizations with  respect to any financing documents with the IFC, the development and  operation of the Corvina Field in Block Z-1, any additional petroleum assets  under license contracts with Perupetro or certain other key agreements; |
|   |                                                                                                                                                                                                                                                                         |
| · | revocation of any financing or security documents  with the IFC or certain key agreements;                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                         |
| · | defaults on certain liabilities;                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                         |
| · | certain judgments against the borrower or any  subsidiary;                                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                         |
| · | failure to make payment on any other liabilities  in excess of $2 million;                                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                         |
| · | engagement in certain sanctionable, such as  fraudulent, coercive or corrupt, practices; or                                                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                         |
| · | restrictions enacted in Peru that could inhibit  any payment a borrower is required to make under the financing documents with  the IFC.                                                                                                                                     |

 

Upon the occurrence of anevent of default or a specified change of control event, each lender under ourdebt facility may: (i) terminate all or part of the relevant facility; (ii) declareall or part of the principal amount of the loan, together with accruedinterest, immediately due and payable;  (iii) declare all or part ofthe principal amount of the loan, together with accrued interest, payable ondemand; or (iv) declare any and all of the security documents under thefacility enforceable and exercise its rights under such documents, includingrights of foreclosure against the collateral. In addition, if any borrower isliquidated or declared bankrupt, all loans and interest accrued on it or anyother amounts due, will become immediately due and payable without notice.

 

The maximum amount availableunder this facility will be reduced by $2.5 million beginning on December 16,2010 and every six months thereafter during the term of the Agreement. The facility is subject to a semi-annual borrowing base determination based onthe value of oil reserves. In the event the amount outstanding exceeds there-determined borrowing base, we could be forced to repay a portion of ourborrowings. We may not have sufficient funds to make any required repayment. Ifwe do not have sufficient funds and are otherwise unable to negotiate renewalsof our borrowings, we may be required to arrange new financing or sell aportion of our assets.

 

Our ability to meet ourcurrent and future debt obligations and other expenses will depend on ourfuture performance, which will be affected by financial, business, economic,regulatory and other factors, many of which we are unable to control.  Ifour cash flow is not sufficient to service our debt, we may be required torefinance the debt, sell assets or sell shares of common stock on terms that wedo not find attractive, if it can be done at all.

 

***Demand for oil and naturalgas is highly volatile and current worldwide demand appears to be declining. Asubstantial or extended decline in oil or natural gas prices may adverselyaffect our business, financial condition, cash flow, liquidity or results ofoperations as well as our ability to meet our capital expenditure obligationsand financial commitments to implement our business plan.***The worseningglobal economy has weakened oil demand. A continued 

 

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slowing of global economicgrowth will likely reduce demand for oil and natural gas, increase spareproductive capacity and result in lower oil and natural gas prices, which willreduce our cash flow from operations.

 

Any revenues, cash flow,profitability and future rate of growth we achieve will be greatly dependentupon prevailing prices for oil and gas. Our ability to maintain or increase ourborrowing capacity and to obtain additional capital on attractive terms is alsoexpected to be dependent on oil and gas prices.

 

Historically, oil and gasprices and markets have been volatile and are likely to continue to be volatilein the future. Oil and natural gas prices have declined significantly over thelast two quarters of 2008 and may continue to decline. In early July 2008,commodity prices reached levels in excess of $140.00 per Bbl of crude oil and$13.00 per Mcf for natural gas. As of January 31, 2009, those prices wererespectively $41.68 per Bbl and $4.40 per Mcf. Oil and natural gas arecommodities, and, therefore, their prices are subject to wide fluctuations inresponse to relatively minor changes in supply and demand for oil and gas,market uncertainty, and a variety of additional factors beyond our control.Those factors include:

 
| · | international political conditions (including wars  and civil unrest);      |
|--------|-----------------------------------------------------------------------------|
|   |                                                                        |
| · | the domestic and foreign supply of oil and gas;                             |
|   |                                                                        |
| · | the level of consumer demand;                                               |
|   |                                                                        |
| · | weather conditions;                                                         |
|   |                                                                        |
| · | domestic and foreign governmental regulations and  other actions;           |
|   |                                                                        |
| · | actions taken by the Organization of Petroleum  Exporting Countries (OPEC); |
|   |                                                                        |
| · | the price and availability of alternative fuels;  and                       |
|   |                                                                        |
| · | overall economic conditions.                                                |

 

Lower oil and natural gasprices may not only decrease our revenues on a per unit basis, but may alsoreduce the amount of oil and natural gas we can produce economically, if any. Acontinuation of low or a further decline in oil and natural gas prices maymaterially affect our future business, financial condition, results ofoperations, liquidity and borrowing capacity, and may require a reduction inthe carrying value of our oil and gas properties. While our revenues mayincrease if prevailing oil and gas prices increase significantly, explorationand production costs and acquisition costs for additional properties andreserves may also increase. We do not enter into hedging arrangements or usederivative financial instruments such as crude oil forward and swap contractsto hedge our risk associated with fluctuations in commodity prices.

 

***Recent changes in thefinancial and credit market may impact economic growth, and combined with therecent volatility of oil and natural gas prices, may also affect our ability toobtain funding on acceptable terms or obtain funding under our proposed creditfacilities.***Global financial markets and economic conditionshave been, and continue to be, disrupted and volatile. Accordingly, the equitycapital markets have become exceedingly distressed. These issues, along withsignificant asset write-offs in the financial services sector, the re-pricingof credit risk and the current weak economic conditions, have made, and willlikely continue to make, it difficult to obtain debt or equity capital funding.

 

In addition, we may beunable to close or obtain adequate funding under our proposed credit facilitiesbecause (i) our lending counterparties may be unwilling or unable to meettheir funding obligations or (ii) our borrowing base under the proposedcredit facilities is decreased as the result of a re-determination, reducing itdue to lower oil or natural gas prices, operating difficulties, declines inreserves, lending requirements or regulations, or for any other reason.

 

Due to these and possiblyother factors, we cannot be certain funding will be available if needed, and tothe extent required, on acceptable terms. If funding is not available asneeded, or is available only on unfavorable terms, we may be unable to meet ourobligations as they come due or we may be unable to implement our exploratoryand development plan, enhance our existing business, complete acquisitions orotherwise take advantage of business opportunities or respond to competitivepressures, any of which could have a material adverse effect on our production,revenues and results of operations.

 

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***Our future operatingrevenue is dependent upon the performance of our properties.*** Our futureoperating revenue depends upon our ability to profitably operate our existingproperties by drilling and completing wells that produce commercial quantitiesof oil and gas and our ability to expand our operations through the successfulimplementation of our plans to explore, acquire and develop 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. No assurance can be giventhat we can produce sufficient revenue to operate our existing properties or acquireadditional oil and gas producing properties and leases. We may not discover orsuccessfully produce any recoverable reserves in the future, or we may not beable to make a profit from the reserves that we may discover. In the event thatwe are unable to produce sufficient operating revenue to fund our futureoperations, we will be forced to seek additional, third-party funding, if suchfunding can be obtained. Such options would possibly include debt financing,sale of equity interests in the Company, joint venture arrangements, or thesale of oil and gas interests. If we are unable to secure such financing on atimely basis, we could be required to delay or scale back our operations. Ifsuch unavailability of funds continued for an extended period of time, thiscould result in the termination of our operations and the loss of an investor’sentire investment.

 

***Our business involves manyuncertainties and operating risks that may prevent us from realizing profitsand can cause substantial losses.*** Our exploration andproduction 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 wellwill not ensure we will realize a profit on our investment. A variety offactors, including geological, regulatory and market-related factors, can causea well to become uneconomical or only marginally economical. Our businessinvolves a variety of operating risks, including:

 
| · | fires;                                                                                                          |
|--------|-----------------------------------------------------------------------------------------------------------------|
|   |                                                                                                            |
| · | explosions;                                                                                                     |
|   |                                                                                                            |
| · | blow-outs and surface cratering;                                                                                |
|   |                                                                                                            |
| · | uncontrollable flows of natural gas, oil and  formation water;                                                  |
|   |                                                                                                            |
| · | natural disasters, such as typhoons and other  adverse weather conditions;                                      |
|   |                                                                                                            |
| · | pipe, cement, subsea well or pipeline failures;                                                                 |
|   |                                                                                                            |
| · | casing collapses;                                                                                               |
|   |                                                                                                            |
| · | mechanical difficulties, such as lost or stuck oil  field drilling and service tools;                           |
|   |                                                                                                            |
| · | abnormally pressured formations; or                                                                             |
|   |                                                                                                            |
| · | environmental hazards, such as natural gas leaks,  oil spills, pipeline ruptures and discharges of toxic gases. |

 

Experiencing any of theseoperating risks could lead to problems with any well bores, platforms,gathering systems and processing facilities, which could adversely affect anydrilling operations we may commence. Affected drilling operations could furtherlead to substantial losses as a result of:

 
| · | 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 requirements, investigations and  penalties;                         |
|   |                                                                            |
| · | suspension of our operations; or                                                |
|   |                                                                            |
| · | repairs to resume operations.                                                   |

 

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If any of these risks occur,we may have to curtail or suspend any drilling or production operations and wecould have our sales of oil interrupted or suspended, which could have amaterial adverse impact on our financial condition, operations and ability toexecute our business plan.

 

***We conduct offshoreexploration, exploitation and production operations off the coast of northwestPeru, all of which are also subject to a variety of operating risks peculiar tothe marine environment.*** Such risks includecollisions, allisions, groundings and damage or loss from adverse weatherconditions or interference from commercial fishing activities. These conditionscan cause substantial damage to facilities, tankers and barges, as well asinterrupt operations. As a result, we could incur substantial liabilities thatcould reduce or eliminate the funds available for exploration, exploitation andacquisitions or result in loss of equipment and properties.

 

***Disruption of services providedby our barges and tankers could temporarily impair our operations and delaydelivery of our oil to be sold.*** We depend on ourdeck barge BPZ-01 to act as a tender for our offshore drilling operations inour Corvina field in Block Z-1. In addition, we have two barges under capitallease to use in support of our offshore oil production operations. One barge isused as a FPSO and the other is currently being used as a floating oil storagefacility (“FSO”). In addition, we have time chartered a double hull tankerbarge to transport crude oil from our offshore production and storagefacilities in Corvina Field to the Talara refinery approximately 70 miles southof the platform where the oil is sold at current market prices under ourcurrent oil contract with Petroperu. See Item 1,- “Business — Customers” forfurther information. These vessels are an important element in our strategy tocontrol drilling, storage and transportation costs by allowing the use ofexisting platforms and avoiding the use of high-priced ships. Any disruption ordelay of the services to be provided by our barges or tanker because of adverseweather conditions, accidents, mechanical failures, insufficient personnel orother events could temporarily impair our operations, delay implementation ofour business plan, and increase our costs.

 

***Our reserve estimatesdepend on many assumptions that may turn out to be inaccurate.  Anymaterial inaccuracies in our reserve estimates or underlying assumptions willmaterially affect the estimated quantities and present value of our reserves.***  Theprocess of estimating oil and natural gas reserves is complex.  Itrequires interpretations of available technical data and many assumptions,including assumptions relating to economic factors that may turn out to beinaccurate.  Any significant inaccuracies in these interpretations orassumptions could materially affect the estimated quantities and thecalculation of the present value of reserves shown in this Annual Report.

 

In order to prepare ourreserve estimates, our independent petroleum engineer must project productionrates and timing of development expenditures as well as analyze availablegeological, geophysical, production and engineering data, and the extent,quality and reliability of this data can vary.  The process also requireseconomic assumptions about matters such as oil and natural gas prices, drillingand operating expenses, capital expenditures, taxes, and availability of funds. Therefore, estimates of oil and natural gas reserves are inherently imprecise.

 

Actual future production,oil and natural gas prices, revenues, taxes, development expenditures,operating expenses and quantities of recoverable oil and natural gas reserveswill most likely vary from our estimates, and those variances may bematerial.  Any significant variance could materially affect the estimatedquantities and present value of our reserves.  In addition, ourindependent petroleum engineer may adjust estimates of proved reserves toreflect production history, drilling results, prevailing oil and natural gasprices and other factors, many of which are beyond our control.

 

One should not assume thatthe net present value of our proved reserves prepared in accordance withCommission guidelines referred to in this Annual Report is the current marketvalue of our estimated oil reserves.  We base the net present value offuture net cash flows from our proved reserves on the date of estimate. Actual future prices, costs, taxes and the volume of produced reservesmay differ materially from those used in the net present value estimate.

 

The Commission currentlypermits oil and natural gas companies, in their public filings with theCommission, to disclose only proved reserves that a company has demonstrated byactual production or conclusive formation tests to be economically and legallyproducible under existing economic and operating conditions. The Commission’sguidelines strictly prohibit us from including “probable reserves” and “possiblereserves” in such filings, although we may disclose such reserves in otherdisclosures not filed with the Commission. We also caution you that theCommission views such “probable” and “possible” reserves estimates asinherently unreliable and these estimates may be seen as misleading toinvestors unless the reader is an expert in the oil or natural gas industry.Unless you have such expertise, you should not place undue reliance on theseestimates. Potential investors should also be aware that such “probable” and “possible”reserve estimates will not be contained in any “resale” or other registrationstatement filed by us that offers or sells shares on behalf of purchasers ofour 

 

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common stock and may have animpact on the valuation of the resale of the shares. Except as required byapplicable law, we undertake no duty to update this information and do notintend to update this information.

 

***Future oil and natural gasdeclines or unsuccessful exploration efforts may result in significant chargesor a write-down of our asset carrying values.***  Wefollow the successful efforts method of accounting for our investments in oiland natural 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 discovered.  If provedreserves are not discovered with an exploratory well, the costs of drilling thewell are expensed.

 

The capitalized costs of ouroil and natural gas properties, on a field basis, cannot exceed the estimatedundiscounted future net cash flows of that field.  If net capitalizedcosts exceed undiscounted future net cash flows, we must write down the costsof each such field to our estimate of its fair marketvalue.  Unproved properties are evaluated at the lower of cost orfair market value.  Accordingly, a significant decline in oil or naturalgas prices or unsuccessful exploration efforts could cause a future write-downof capitalized costs.

 

We evaluate impairment ofour proved oil and gas properties whenever events or changes in circumstancesindicate an asset’s carrying amount may not be recoverable. In addition,write-downs would occur if we were to experience sufficient downwardadjustments to our estimated proved reserves or the present value of estimatedfuture net revenues.  Once incurred, a write-down of oil and natural gasproperties cannot be reversed at a later date even if oil or natural gas pricesincrease.

 

***Our management team haslimited experience in the power generation business.***Our plan ofoperation includes constructing power generation and gas processing facilitiesand pipelines in Peru and Ecuador. However, the experience of our managementteam has primarily been in the oil and natural gas 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. In addition we are currently searching for aprospective joint venture partner to participate in our gas-to-power project.

 

***Construction and operationof power generation and gas processing facilities and pipelines involvesignificant risks and delays that cannot always be covered by insurance or contractualprotections.*** The construction of power generation and gasprocessing facilities and pipelines involve many risks, including:

 

·                  supply interruptions;

 

·                  work stoppages;

 

·                  labor disputes;

 

·                  social unrest;

 

·                  inability to negotiateacceptable construction, supply or other contracts;

 

·                  inability to obtain requiredgovernmental permits and approvals;

 

·                  weather interferences;

 

·                  unforeseen engineering,environmental and geological problems;

 

·                  unanticipated cost overruns;

 

·                  possible delays in theacquisition of necessary gas turbines;

 

·                  possible delays inconnection with power plant construction;

 

·                  possible delays ordifficulties in completing financing arrangements for the gas-to-power project;and

 

·                  possible difficulties ordelays with respect to any necessary Peruvian regulatory compliance.

 

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The ongoing construction andfuture operation of these facilities involve all of the risks described above,in addition to risks relating to the breakdown or failure of equipment orprocesses and performances below expected levels of output or efficiency. Weintend to maintain commercially reasonable levels of insurance where suchinsurance is available and cost-effective, obtain warranties from vendors andobligate contractors to meet certain performance levels. However, the coverageor proceeds of any such insurance, warranties or performance guarantees may notbe adequate to cover lost revenues or increased expenses. Any of these riskscould cause us to operate below expected capacity levels, which in turn couldresult in lost revenues, increased expense and higher costs.

 

***The success of ourgas-to-power project depends, in part, on the existence and growth of marketsfor natural gas and electricity 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 onhydroelectric generating capacity for a significant portion of their powerdemand. Hydroelectric plants are much less expensive to operate than plantsthat utilize natural gas, but they are subject to variable output based onrainfall and reservoir levels. The majority of the non-hydroelectric or thermalpower capacity in both countries consists of generating plants that utilizediesel or fuel oil, which are significantly more costly than natural gas atthis time. Both countries have natural gas reserves and production, but neitherhas a well-developed natural gas infrastructure. Our immediate business planrelies on the continued stability of the power market in Peru (and Ecuador forthe purpose of gas sales to third-party power producers in Ecuador), and ourlonger-term plans depend on the further development of the electricity marketin Ecuador. We currently do not expect to complete our power plant until 2011.Our assessment of the future power market and demand in Peru and Ecuador couldbe inaccurate. We are subject to the risks that:

 

·                  relatively more favorablebusiness conditions for hydroelectric plants, a material reduction in powerdemand or other competitive issues may adversely affect the demand and pricesfor the electricity that we expect to produce by the time the power plant iscompleted;

 

·                  our lifting costs couldexceed the minimum wholesale power prices available, making the sale of our gasuneconomical;

 

·                  potential disruptions orchanges to regulations of the natural gas or power markets in these countriescould occur by the time our power plant is completed, or we may not receive thenecessary environmental or other permits and governmental approvals to operateour power plant;

 

·                  although we plan to enterinto long-term contracts to sell a significant part of our future powerproduction, there can be no assurance that we will be successful in obtaining suchcontracts or that they will be on favorable terms; and

 

·                  we will also be subject tothe general commercial issues related to being in the power business, includingthe credit-worthiness of, and collections from future customers and the abilityto profitably operate our future power plants.

 

***The geographicconcentration of our properties in northwest Peru and southwest Ecuadorsubjects us to an increased risk of loss of revenue or curtailment ofproduction from factors affecting that region specifically.*** The geographicconcentration of our properties in northwest Peru and southwest Ecuador andadjacent waters means that some or all of our properties could be affected bythe same event should that region, for example, experience:

 

·                  severe weather (such as theeffects of “El Niño,” which can cause excessive rainfall and flooding in Peruand Ecuador);

 

·                  delays or decreases inproduction, the availability of equipment, facilities or services;

 

·                  delays or decreases in theavailability of capacity to transport, gather or process production; or

 

·                  changes in the political orregulatory environment.

 

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Because all our propertiescould experience the same conditions at the same time, these conditions couldhave a relatively greater impact on our results of operations than they mighthave on other operators who have properties over a wider geographic area.

 

***Along with the generalinstability that comes from international operations, we face political andgeographical risk specific to working in South America.*** Presently, allof our oil 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,including:

 

·                                          economic,labor, and social conditions

 

·                                          local andregional political instability;

 

·                                          tax laws(including host-country export, excise and income taxes and U.S. taxes onforeign operations); and

 

·                                          fluctuations inthe value of the U.S. dollar versus the local currencies in which oil and gasproducing activities may be conducted.

 

This instability in laws,expenses of operations and fluctuations in exchange rates may make ourassumptions about the economic viability of our oil and gas propertiesincorrect. If these assumptions are incorrect, we may not be able to earnsufficient revenue to cover our costs of operations.

 

***Our operations in Peru andEcuador involve substantial costs and are subject to certain risks because theoil and gas industry in Peru and Ecuador is less developed when compared to theUnited States.*** Because the oil and gas industry in Peru andEcuador is less developed than in the United States, our drilling anddevelopment operations in many instances will take longer to complete and maycost more than similar operations in the United States. The availability oftechnical expertise, specific equipment and supplies may be more limited orcostly in Peru and Ecuador than in the United States. If we are unable toobtain or unable to obtain without undue cost drilling rigs, equipment,supplies or personnel, our exploitation and exploration operations could bedelayed or adversely affected, which could have a material adverse effect onour business, financial condition or results of operations. Furthermore, onceoil and natural gas production is recovered, there are fewer ways to transportit to market for sale. Pipeline and trucking operations are subject touncertainty and lack of availability. Oil and natural gas pipelines and trucktransport travel through miles of territory and are subject to the risk ofdiversion, destruction or delay. We expect that such factors will continue tosubject our international operations to economic and operating risks thatcompanies with domestic operations do not experience.

 

***We are subject to numerousforeign laws and regulations of the oil and natural gas industry that canadversely affect the cost, manner or feasibility of doing business.*** Our operationsare subject to extensive foreign laws and regulations relating to theexploration for and the development, production and transportation of oil and naturalgas as well as electrical power generation. Because the oil and gas industry inthe countries in which we operate is less developed than elsewhere, changes inlaws and interpretations of laws are more likely than in countries with a moredeveloped oil and gas industry. Future laws or regulations, as well as anyadverse change in the interpretation of existing laws or our failure to complywith existing legal requirements may harm our results of operations andfinancial condition. In particular, there are indications that the currentadministration in Ecuador is likely to increase state intervention in theeconomy via new legislation and tightening control of areas such as energy,which could have a significant impact on our ability to operate in that country.We may be required to make large and unanticipated capital expenditures tocomply with governmental regulations, such as:

 

·                  work program guarantees andother financial responsibility requirements;

 

·                  taxation;

 

·                  royalty requirements;

 

·                  customer requirements;

 

·                  operational reporting; and

 

·                  safety requirements.

 

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Under these laws andregulations, we could be liable for:

 

·                  personal injuries;

 

·                  property and naturalresource damages; and

 

·                  governmental infringementsand sanctions.

 

***If we fail to comply withthe terms of certain contracts related to our foreign operations, we could loseour rights under each of those contracts.*** The terms of each of ourcontracts with the government of Peru, including our Peruvian oil and gaslicense contracts require that we perform certain activities, such as seismicacquisition, processing and interpretations and the drilling of required wellsin accordance with those contracts and agreements. We are also required toconduct environmental impact assessments and establish our ability to complywith environmental regulations. Our failure to timely perform those activitiesas required could result in the suspension of our current production and saleof oil, the loss of our rights under a particular contract and/or the loss ofthe amounts we have posted as a guaranty for the performance of suchactivities, which would result in a significant loss to us.

 

*** We are subject tothe Foreign Corrupt Practices Act (the “FCPA”), and our failure to comply withthe laws and regulations thereunder could result in penalties which could harmour reputation and have a material adverse effect on our business, results ofoperations and financial condition.***  We are subject to theFCPA, which generally prohibits companies and their intermediaries from makingimproper payments to foreign officials for the purpose of obtaining or keepingbusiness and/or other benefits. Since all of our oil and gas properties are inPeru and Ecuador, there is a risk of potential FCPA violations.  We have aFCPA policy and a limited compliance program designed to ensure that theCompany, its employees and agents comply with the FCPA.  There is noassurance that such policy or program will work effectively all of the time orprotect us against liability under the FCPA for actions taken by our agents,employees and intermediaries with respect to our business or any businessesthat we acquire.  Any violation of these laws could result in monetarypenalties against us or our subsidiaries and could damage our reputation and,therefore, our ability to do business.

 

***We are subject to complexenvironmental regulatory and permitting laws and regulations that can adverselyaffect the cost, manner and feasibility of our planned operations.*** Theexploration for, and the development, production and sale of, oil and gas inSouth America are subject to extensive environmental laws and regulations. Ourability to conduct continued operations is subject to satisfying applicableregulatory and permitting controls. For example, we are required to obtain anenvironmental permit or approval from the government in Peru prior toconducting seismic operations, drilling a well or constructing a pipeline inPeruvian territory, including the waters offshore of Peru, where we intend toconduct future oil and gas operations. We are also required to comply withnumerous environmental regulations in order to continue commercial sales of oilbeyond the well test period currently in effect in Block Z-1, which will likelybe required to be concluded by or before May 31, 2010. Additionally,environmental laws and regulations promulgated in Peru impose substantialrestrictions on the use of natural resources, interference with the naturalenvironment, location of facilities, handling and storage of hydrocarbons, useof radioactive material, disposal of waste, emission of noise and otheractivities. The laws create additional monitoring and reporting obligations inthe event of any spillage or unregulated discharge of hydrocarbons. Failure to complywith these laws and regulations also may result in the suspension ortermination of our planned drilling operations and subject us toadministrative, civil and criminal penalties.

 

Our current permits andauthorizations and our ability to get future permits and authorizations may,over time, be susceptible to increased scrutiny, resulting in increased costs,or delays in receiving appropriate authorizations. In particular, we mayexperience delays in obtaining permits and authorizations in Peru and Ecuadornecessary for our operations, including those required to continue commercialsales of oil beyond the well test period, which will likely be required to beconcluded by or before May 31, 2010. Compliance with these laws andregulations may increase our costs of operations, as well as further restrictour foreign operations. Moreover, these laws and regulations could change inways that substantially increase our costs. These laws and regulations havechanged in the past and have generally imposed more stringent requirements thatincrease operating costs or require capital expenditures in order to remain incompliance. It is also possible that unanticipated developments could cause usto make environmental expenditures that are significantly higher than those wecurrently anticipate, thereby increasing our overall costs. Failure to complywith new regulations could cause us to suspend or terminate certain operationsor subject us to administrative, civil or criminal penalties. Any of theseliabilities, penalties, suspensions, terminations or regulatory changes couldmaterially adversely affect our financial condition and our ability toimplement our plan of operation.

 

***Compliance with, or breachof, laws relating to the discharge of materials into, and the protection of,the environment can be costly and could limit our operations.*** As an owner orlessee and operator of oil and gas properties in 

 

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Peru and Ecuador, we aresubject to various national, state and local laws and regulations relating todischarge of materials into, and protection of, the environment. These laws andregulations may, among other things, impose liability on the owner or lesseeunder an oil and gas lease for the cost of property damage, oil spills,discharge of hazardous materials, remediation and clean-up resulting fromoperations, subject the owner or lessee to liability for pollution damages andother environmental damages, and require suspension or cessation of operationsin affected areas or related sales of oil and gas.

 

We have establishedpractices for continued compliance with environmental laws and regulations andwe believe the costs incurred by these policies and procedures so far have beennecessary business costs in the oil and gas industry. However, there is noassurance that changes in or additions to laws or regulations regarding theprotection of the environment will not increase such compliance costs, or havea material adverse effect upon our capital expenditures, earnings orcompetitive position.

 

***Our oil and gas operationsinvolve substantial costs and are subject to various economic risks.*** Our oil andgas operations are subject to the economic risks typically associated withexploration, development and production activities, including the necessity ofsignificant expenditures to locate and acquire producing properties and todrill exploratory wells. The cost and length of time necessary to produce anyreserves may be such that it will not be economically viable. In conductingexploration and development activities, the presence of unanticipated pressureor irregularities in formations, miscalculations or accidents may cause ourexploration, development and production activities to be unsuccessful. Inaddition, the cost and timing of drilling, completing and operating wells isoften uncertain. We also face the risk that the oil and/or gas reserves may beless than anticipated, that we will not have sufficient funds to successfullydrill on the property, that we will not be able to market the oil and/or gasdue to a lack of a market and that fluctuations in the prices of oil and/or gaswill make development of those leases uneconomical. This could result in atotal loss of our investments made in our operations.

 

***Competition for oil andnatural gas properties and prospects is intense; many of our competitors havelarger financial, technical and personnel resources that give them an advantagein evaluating and obtaining properties and prospects.*** We operate ina highly competitive environment for reviewing prospects, acquiring properties,marketing oil and natural gas and securing trained personnel and equipment. Inaddition, changes in Peruvian government regulation have enabled multinationaland regional companies to enter the Peruvian energy market. We actively competewith other companies in our industry when acquiring new leases or oil and gasproperties. Competition in our business activities has increased and willincrease further, as existing and new participants expand their activities as aresult of these regulatory changes. Many of our competitors possess and employfinancial resources that allow them to obtain substantially greater technicaland personnel resources than we have. For example, if several companies areinterested in an area, Perupetro (a state company responsible for promoting andoverseeing the investment of hydrocarbon exploration and exploitation activitiesin Peru) may choose to call for bids, either through international competitivebiddings or through private bidding processes by invitation, and award thecontract to the highest bidder. These additional resources can be particularlyimportant in reviewing prospects and purchasing properties. Our competitors maybe able to evaluate, bid for and purchase a greater number of properties andprospects than our financial or personnel resources permit. Our competitors mayalso be able to pay more for productive oil and natural gas properties andexploratory prospects than we are able or willing to pay. On the acquisitionopportunities made available to us, we compete with other companies in ourindustry for properties operated by third parties through a private biddingprocess, direct negotiations or some combination thereof. Our ability toacquire additional prospects and to find and develop reserves in the futurewill depend on our ability to evaluate and select suitable properties and toconsummate transactions in a highly competitive environment. If we are unableto compete successfully in these areas in the future, our future revenues andgrowth may be diminished or restricted. The availability of properties foracquisition depends largely on the divesting practices of other oil and naturalgas companies, commodity prices, general economic conditions and other factorswe cannot control or influence.

 

***The loss of seniormanagement or key technical personnel could adversely affect us.*** We haveengaged certain members of management who have substantial and unique expertisein the type of endeavors we presently conduct and the geographical areas inwhich we conduct them. We do not maintain any life insurance against the lossof any of these individuals. To the extent their services become unavailable,we will be required to retain other qualified personnel. There can be noassurance we will be able to recruit and hire qualified persons upon acceptableterms. Similarly, the oil and gas exploration industry requires the use ofpersonnel with substantial technical expertise. In the event that the servicesof our current technical personnel become unavailable, we will need to hirequalified personnel to take their place. No assurance can be given that we willbe able to recruit and hire such persons on acceptable terms. Inability toreplace lost members of management or personnel may adversely affect us.

 

***Insurance does not coverall risks.*** Exploration for, and production of, oil and naturalgas can be hazardous, involving unforeseen occurrences such as blowouts,cratering, fires and loss of well control, which can result in damage to or 

 

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destruction of wells orproduction facilities, formations, injury to persons, loss of life, or damageto property or the environment. As a result, we presently maintain insurancecoverage in amounts consistent with our business activities and to the extentrequired by our license contracts. Such coverage includes certain physicaldamage to the Company’s and third parties’ property, hull and machinery,protection and indemnity, employer’s liability, comprehensive third partygeneral liability, workers compensation and certain pollution and environmentalrisks. However, we are not fully insured against all risks in all aspects ofour business, such as political risk, civil unrest, war, business interruption,environmental damage and reservoir loss or damage. Further, no such insurancecoverage can insure for all operational or environmental risks. The occurrenceof an event that is not insured or not fully insured could result in losses tous. For example, uninsured or under insured environmental damages, propertydamages or damages related to personal injuries could divert capital needed toimplement our plan of operation. If any such uninsured losses are significant,we may have to curtail or suspend our drilling operations until such time asreplacement capital is obtained, if ever, and this could have a materialadverse impact on our financial position.

 

***We may not be able toreplace our reserves.*** Our future success will depend upon ourability to find, acquire and develop oil and gas reserves that are economicallyrecoverable. Any reserves we develop will decline as they are produced unlesswe are able to conduct successful revitalization activities, or are able toacquire properties containing proven reserves, or both. To develop reserves andachieve production, we must implement our development and production programs,identify and produce previously overlooked or by-passed zones and shut-inwells, acquire additional properties or undertake other replacement activities.We can give no assurance that our planned development, revitalization, andacquisition activities will result in significant reserves replacement or thatwe will have success in discovering and producing reserves at economicalexploration and development costs. We may not be able to locate geologicallysatisfactory property, particularly since we will be competing for suchproperty with other oil and gas companies, most of which have much greaterfinancial resources than we do. Moreover, even if desirable properties areavailable to us, we may not have sufficient funds with which to acquire ordevelop them.

 

**Risks Relating to Our Securities**

 

***Investor profits,if any, may be limited for the near future.***In the past, we have never paid a dividend. We do notanticipate paying any dividends in the near future. Accordingly, investors inour common stock may not derive any profits from their investment in us for theforeseeable future, other than through any price appreciation of our commonstock that may occur. Further, any appreciation in the price of our commonstock may be limited or nonexistent as long as we continue to have operatinglosses. We have not been profitable and have accumulated deficits of operationstotaling $67.9 million through December 31, 2008. To date we have hadlimited revenue and no earnings from operations.  There can be noassurances that sufficient revenue to cover total expenses can be achieveduntil, if at all, we fully implement our operational plan.

 

***Additionalinfusions of capital may have a dilutive effect on existing shareholders.***To finance our operations we may selladditional shares of our common stock. Our certificate of formation does notprovide for preemptive rights. We currently have $222 million in common stockavailable under an effective shelf registration statement, which we may sellfrom time to time in one or more offerings pursuant to underwritten publicofferings, negotiated transactions, block trades or a combination of thesemethods.  Any additional equity financing that we receive may involvesubstantial dilution to our then-existing shareholders. Furthermore, we mayissue common stock to acquire properties, assets, or businesses. In the eventthat any such shares are issued, the proportionate ownership and voting powerof other shareholders will be reduced. In addition, we are authorized to issueup to 25,000,000 shares of preferred stock, the rights and preferences of whichmay be designated by our Board of Directors. If we issue shares of preferredstock, such preferred stock may have rights and preferences that are superiorto those of our common stock.

 

***Shares eligible forfuture sale by our current shareholders may impair our ability to raise capitalthrough the sale of our stock.***As of December 31, 2008, we had 78,748,390 sharesof common stock issued and outstanding. In addition, we have outstanding3,894,348 shares of other potentially dilutive securities, which mainly consistof options granted under our 2005 Long-Term Incentive Compensation Plan, asamended and restated.  We also have an additional 2,514,450 shares ofcommon stock allocated under our 2007 Long-Term Incentive Compensation Plan, asamended and restated, and our 2007 Directors’ Compensation IncentivePlan.  The possibility that substantial amounts of shares of our common stockmay be sold in the public market may cause prevailing market prices for ourcommon stock to decrease and thus could impair our ability to raise capitalthrough the sale of our equity securities.

 

***We are controlledby our officers, directors and entities affiliated with them.***In the aggregate, our management anddirectors own or control approximately 22.2% of our common stock issued as of December 31,2008. These 

 

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shareholders, if actingtogether, will be able to significantly influence all matters requiringapproval by our shareholders, including the election of directors and theapproval of mergers or other business combination transactions.

 

***Our corporateorganizational documents and the provisions of Texas law to which we aresubject may delay or prevent a change in control of us that some shareholdersmay favor.***Ourcertificate of formation and bylaws contain provisions that, either alone or incombination with the provisions of Texas law described below, may have theeffect of delaying or making it more difficult for another person to acquire usby means of a hostile tender offer, open market purchases, a proxy contest orotherwise. These provisions include:

 

·                  A board of directors classified into three classes of directors witheach class having staggered, three-year terms. As a result of this provision,at least two annual meetings of shareholders may be required for theshareholders to change a majority of our board of directors.

 

·                  The board’s authority to issue shares of preferred stock withoutshareholder approval, which preferred stock could have voting, liquidation,dividend or other rights superior to those of our common stock. To the extentany such provisions are included in any preferred stock, they could have theeffect of delaying, deferring or preventing a change in control.

 

·                  Our shareholders cannot act by less than unanimous written consent andmust comply with the provisions of our bylaws requiring advance notification ofshareholder nominations and proposals. These provisions could have the effectof delaying or impeding a proxy contest for control of us.

 

·                  Provisions of Texas law, which we did not opt out of in our certificateof formation, that restrict business combinations with “affiliated shareholders”and provide that directors serving on staggered boards of directors, such asours, may be removed only for cause.

 

Any or all of these provisions could discourage tenderoffers or other business combination transactions that might otherwise resultin our shareholders receiving a premium over the then current market price ofour common stock.

 

***The market priceand trading volume of our common stock may be volatile.***The market price of our common stock maybe highly volatile and subject to wide fluctuations. In addition, the tradingvolume in our common stock may fluctuate and cause significant price variationsto occur. If the market price of our common stock declines significantly, youmay be unable to resell your shares at or above the price at which the shareswere acquired. We cannot assure you that the market price of our common stockwill not fluctuate or decline significantly in the future. Some of the factorsthat could adversely affect our share price or result in fluctuations in theprice or trading volume of our common stock include:

 

·                  actual or anticipated fluctuations in our results of operations;

 

·                  failure to be covered by securities analysts, or failure by us to meetsecurities analysts’ expectations;

 

·                  success of our operating strategies;

 

·                  decline in the stock price of companies that are our peers;

 

·                  realization of any of the risks described in this section; or

 

·                  general market and economic conditions.

 

Because we are a relatively new public company, thesefluctuations may be more significant for us than they would be for a companywhose stock has been publicly traded over an extended period of time.

 

In addition, the stock market has experienced in thepast, and may in the future experience extreme price and volume fluctuations.These market fluctuations may materially and adversely affect the trading priceof our common stock, regardless of our actual operating performance.

 

**ITEM 1B. UNRESOLVED STAFF COMMENTS**

 

None

 

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**ITEM 2. PROPERTIES**

 

**Offices**

 

Our corporate headquarters office is locatedin Houston, Texas. In November 2008, we entered into a coterminous leasefor the existing office space extending the current leased space ofapproximately 7,770 square feet of office space and 2,580 square feet ofadjacent office space. This new lease extends the old lease terms seven-yearsand expires on January 31, 2016. Under this new lease agreement, we areobligated to lease an additional 7,070 square feet of office space with leasepayments commencing in March of 2009. We also currently lease fouradministrative offices and a warehouse in Peru of approximately 12,100 squarefeet and 57,000 square feet, respectively. The leases expire at various timesin 2009 and 2010. In 2008, our Lima, office entered into a lease agreement,beginning in March of 2009 and expiring in fourth quarter of 2013, to leasea consolidated office space of approximately 22,500 square feet. Additionallywe lease an administrative office in Quito, Ecuador of 829 square feet under amonth-to-month lease.

 

**Properties in Peru**

** **

** **

** **

We currently have exclusive rights to fourproperties in northwest Peru. We have a 100% working interest in licensecontracts for Block Z-1, Block XIX, Block XXII and Block XXIII. The licensecontracts afford an initial exploration phase of seven and potentially up toten years (seven and potentially up to thirteen for Block Z-1), and, ifexploration efforts are successful, provide a total contract term of up to 30years for oil exploration and production and up to 40 years for gasexploration and production. These four blocks cover a combined area of approximately2.4 million acres.

 

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The following table is a summary of ourproperties in northwest Peru. As of December 31, 2008 only acreage inBlock Z-1 has been partially developed.

 
| **PROPERTY** | ** ** | **BASIN**       | ** ** | **BPZ’S  OWNERSHIP** | ** ** | **LICENSE  CONTRACT  SIGNED** | ** **         | **UNDEVELOPED  ACRES** | ** ** | **DEVELOPED  ACRES** | ** ** | **PRODUCTIVE  WELLS (1)** | ** ** |
|--------------|------------|-----------------|------------|---------------------------|------------|-------------------------------|--------------------|------------------------|------------|----------------------|------------|--------------------------------|------------|
| ** **   | ** ** | ** **      | ** ** | ** **                | ** ** | ** **                    | ** **         | ** **             | ** ** | ** **           | ** ** | ** **                     | ** ** |
| Block Z-1    |       | Tumbes/Talara   |       | 100                       | %          |                          | November 2001 |                   | 738,996    |                 | 209        |                           | 4          |   |
| Block XIX    |       | Tumbes/Talara   |       | 100                       | %          |                          | December 2003 |                   | 472,860    |                 |       |                           |       |   |
| Block XXII   |       | Lancones/Talara |       | 100                       | %          |                          | November 2007 |                   | 948,000    |                 |       |                           |       |   |
| Block XXIII  |       | Tumbes/Talara   |       | 100                       | %          |                          | November 2007 |                   | 248,000    |                 |       |                           |       |   |
| Total        |       |            |       |                      |       |                          |               |                   | 2,407,856  |                 | 209        |                           | 4          |   |

 

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**(1)****                                **Doesnot include the****CX11-16X well which testedquantities of gas which we believe to be of commercial amounts and is currentlyshut-in. Until such time as sufficient funding has been secured for our gas-topower project, we cannot include any of these reserves as part of our SECreserves nor include the well(s) as productive.

 

**Description of Block Z-1 and License Contract**

 

Block Z-1, a coastal offshore areaencompassing approximately 739,205 acres, is situated at the southern end of theGulf of Guayaquil in northwest Peru. Geologically, the block lies within theTumbes Basin. From the coastline, water depths increase gradually. The averagewater depth of the area is approximately 200 feet and approximately 10% of thearea has depths ranging from 500 feet up to 1,000 feet. Located within BlockZ-1 are five structures which were drilled in the 1970s and 1980s by previousoperators, including Tenneco, Inc. and Belco Oil and Gas Corporation (“Belco”).These structures are known as the Albacora, Barracuda, Corvina, Delfin andPiedra Redonda fields. Wells drilled in each of these structures tested positivefor oil or gas in what webelieve to be economic quantities 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.Consequently, the wells were either suspended or abandoned.

 

In the Corvina Field, five wells weredrilled, including two wells drilled by Tenneco in the mid-1970s and threewells drilled by Belco in the late 1970s and early 1980s. Two drilling andproduction platforms were set up by Belco during this period and are still inplace in the Corvina Field. The platforms need to be repaired and refurbished,but are structurally sound, and we believe suitable for our future operations.All five wells in the Corvina Field encountered indications of natural gas andapparent reservoir-quality formations, although only one of the wells, theCX11-16X, was completed and tested. At the time these wells were drilled, therewas no commercial market for natural gas in the region. The CX11-16X producednatural gas 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. Thewell was shut-in. In June 2007, we successfully recompleted the CorvinaCX11-16X well as a natural gas producing well and completed a total of fourdrill stem tests on various zones in the well including one in a formationpreviously untested in the entire basin. The tests produced quantities of gaswe believe to be in commercial amounts.

 

In the Piedra Redonda Field, two wells weredrilled by Belco in the late 1970s and early 1980s. Indications of natural gaswere present in both wells. One well was completed, while the other wellencountered abnormally high pressures and was abandoned for mechanical reasonsprior to reaching its intended total depth. The completed well in the PiedraRedonda Field, the C18X, produced natural gas at rates as high as 8.3 MMcf/dover a period of approximately 20 days during an extended test in 1979 andwas also shut-in.

 

We originally acquired our initial interestin Block Z-1 in a joint venture with Syntroleum Peru Holdings Limited, sucursaldel Peru, under an exploration and production license contract dated November 30,2001, with an effective date of January 29, 2002. Under the originalcontract, BPZ owned a 5% non-operating working interest, along with the rightof first refusal, in the block. Syntroleum later transferred its interest toNuevo Peru ltd., sucursal del Peru. Subsequent to the merger of Nuevo Energy, Inc.and Plains Exploration and Production Company, Nuevo Energy, Inc.transferred its interest in Block Z-1 to BPZ which then assumed a 100% workinginterest, as well as the remaining obligations under the contract. Perupetroapproved the assumption of Nuevo’s interest by BPZ and the designation of BPZas a qualified operator under the contract in November 2004. This actionwas subject to official ratification and issuance of a Supreme Decree by thegovernment of Peru, which was issued in February 2005. Accordingly, anamended contract was signed with Perupetro, naming BPZ as the owner of 100% ofthe participation under the license contract.

 

The license contract provides for an initialexploration phase of seven years, which is divided into four periods, and canbe extended under certain circumstances up to an additional six years. Eachperiod has a commitment for exploration

 

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activities and requires a financial guarantee to secure the performanceof the work commitment during such period. Block Z-1 is currently in the thirdexploration period. This period was originally scheduled to expire in November 2008. However, since Albacora Drilling Environmental Impact Study is still pendingfor approval from DGAAE (Dirección General de Asuntos Ambientales yEnergéticos), who is responsible for environmental protection matters in Peru,the third exploration period time limit is on suspension until such approval isobtained from the DGAAE. The fourth and final exploration period will begin assoon as the third period expires. It will also require the drilling of anadditional exploratory well or other equivalent work commitments and willrequire a performance bond of $1.0 million. A performance bond of $1.0 millionwas posted for cash collateral of $750,000 related to the third explorationperiod. The performance bond amounts are not cumulative, and are released atthe end of each exploration period if the work commitment for that period hasbeen satisfied. In addition, we are required to make technology transferpayments related to training costs of Perupetro professional staff during theexploration phase of $50,000 per year.

 

On November 21, 2007, we submitted aletter to Perupetro declaring a commercial discovery in the Block Z-1 field. OnMay 19, 2008 we filed the field development plan with Perupertro. The commercial development period of the contract will commence on the FirstDate of Commercial production (“FDCP”). The date of beginning of commercialextraction is currently under revision with Perupetro. Under the contract, oilexploration, development and production can continue for a total of up to 30years from the effective date of the contract, and gas exploration, developmentand production can continue for up to 40 years. Royalties under the contractvary from 5% to 20% based on production volumes. Royalties start at 5% if andwhen production is less than 5,000 barrels of oil equivalent per day (boepd)and are capped at 20% if and when production surpasses 100,000 boepd.

 

**Description of Block XIX and License Contract**

 

Block XIX covers approximately 472,860 acres,lying entirely onshore and adjacent to Block Z-1 in northwest Peru.Geologically, the block lies primarily within the Tumbes Basin ofOligocene-Neogene age, but also covers part of the Talara Basin to the south.Several older wells showed evidence of gas potential in the Mancora formationas well as oil show from the Heath Formation. The sections of the Tumbes andTalara Basins in Block XIX are primarily exploratory areas and have had limiteddrilling and seismic activity. However, the Mancora formation is expected tocontinue from offshore in Block Z-1 in Piedra Redonda through Block XXIII, alsounder license to us, and into Block XIX an area which spans approximately fiftymiles.

 

In February 2003, we entered into aTechnical Evaluation Agreement with Perupetro for Block XIX. In December 2003,we signed a license contract whereby we acquired a 100% interest in Block XIX.The term for the exploration period is seven years and can be extended undercertain circumstances for an additional period of up to three years. If acommercial discovery is made during the exploration period, the contract willallow for the exploration and production of oil for a period of 30 years fromthe effective date of the contract and the exploration and production of gasfor a period of 40 years. Royalties under the contract vary from 5% to 20%based on production volumes. Royalties start at 5% if and when production isless than 5,000 barrels of oil equivalent per day (boepd) and are capped at 20%if and when production surpasses 100,000 boepd.

 

The seven year exploration phase is dividedinto five periods of 18 months, 24 months, 15 months, 15 months and 12 months,respectively. As of December 31, 2008, we had a $585,000 bond posted for$292,500 in cash collateral. We are currently in the third exploration period,which was scheduled to end in May of 2009. However, in accordance with theterms of the license contract, we intend to postpone the thirdexploration period of Block XIX to 2010. During the third explorationperiod, we will be required to drill and test one well. In connection with thethird exploration period, which began in February 2008, the performancebond associated with the second exploration period was released. Once wecomplete the third exploration period we will reestablish timelines for thefourth and fifth exploration periods. Both the fourth and fifth explorationperiods will require a performance bond of $585,000 for each respective period.The performance bond amounts are not cumulative, and will be released at theend of each exploration period if the work commitment for that period has beensatisfied. In addition, we are required to make technology transfer paymentsrelated to training costs of Perupetro professional staff during theexploration phase in the amount 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 end of the lastexploration period, including any extensions or deferments.

 

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**Description of Block XXII and LicenseContract**

 

On November 21, 2007, we signed alicense contract whereby we acquired a 100% interest in Block XXII. Block XXIIis located onshore in northwest Peru within the Lancones Basin ofCretaceous—Upper Eocene Age and covers an area of approximately 948,000 acres.The Lancones Basin is primarily an exploratory area and has had limiteddrilling and seismic activity. The southern sector of this block also coversthe productive Talara basin of northwest Peru, near the Talara Refinery. Theexploration period of the license contract extends over a seven year perioddivided into five periods or four periods of 18 months and a final period of 12months. Under certain circumstances, the exploration periods may be extendedfor an additional period of up to three years. We are in the first explorationperiod which requires that we acquire, process and interpret 200 kms of 2-Dseismic data and prepare a comprehensive geological and engineering study forthe area. In each subsequent period after the first 18 month period we arerequired to drill an exploratory well. If a commercial discovery is made duringthe exploration period, the contract will allow for the exploration andproduction of oil for a period of 30 years from the effective date of thecontract and the exploration and production of gas for a period of 40 years.Royalties under the contract vary from 15% to 30% based on production volumes.Royalties start at 15% if and when production is less than 5,000 barrels of oilequivalent per day (boepd) and are capped at 30% if and when productionsurpasses 100,000 boepd.

 

In connection with the first explorationperiod, we were required to obtain a cash collateralized $600,000 bond for cashcollateral in the amount of $300,000. The performance bond amounts are notcumulative, and will be released at the end of each exploration period if thework commitment for that period has been satisfied.

 

**Description of Block XXIII and LicenseContract**

 

On November 21, 2007, we signed alicense contract whereby we acquired a 100% interest in Block XXIII, whichconsists of approximately 248,000 acres and is located onshore in northwestPeru between Blocks Z-1 and XIX. This block is located in the Tumbes basin,although in its southern section Talara Basin sediments may be found deeper.The sections of the Tumbes and Talara Basins in Block XXIII are primarilyexploratory areas and have had limited drilling and seismic activity. Theexploration period of the license contract extends over a seven year perioddivided in to two periods of 18 months and two periods of 24 months. Inaddition, it commits the Company to drill a certain number of wells, acquire certainamount of either 2-D or 3-D seismic data and prepare an integrated geological,geochemical and reservoir engineering evaluation of the hydrocarbon prospectsin the block. In connection with this block we posted a performance bond toguarantee our various obligations and commitments. If a commercial discovery ismade during the exploration period, the contract will allow for the explorationand production of oil for a period of 30 years from the effective date of thecontract and the exploration and production of gas for a period of 40 years.Royalties under the contract vary from 15% to 30% based on production volumes.Royalties start at 15% if and when production is less than 5,000 barrels of oilequivalent per day (“boepd”) and are capped at 30% if and when productionsurpasses 100,000 boepd.

 

In connection with the first explorationperiod, we were required to obtain a cash collateralized $3,075,000 bond in theamount of $1,537,500. The performance bond amounts are not cumulative, and willbe released at the end of each exploration period if the work commitment forthat period has been satisfied.

 

**Proved Reserves**

 

Our estimated proved oil reserve quantitieswere prepared by Netherland, Sewell & Associates, Inc. (“NSAI”),independent petroleum engineers. NSAI was chosen based on their knowledge andexperience of the region in which we operate. Numerous uncertainties arise inestimating quantities of proved reserves and projecting future rates ofproduction and the timing of development expenditures. These uncertainties aregreater for properties which are undeveloped or have a limited productionhistory, such as in Northern Peru. Our actual reserves, future rates ofproduction and timing of development expenditures may vary substantially fromthese estimates. All of our proved reserves are in the Corvina Field. Our netquantities of proved developed and undeveloped reserves of crude oil andstandardized measure of future net cash flows are reflected in the table below.See further information about the basis of presentation of theses amount in “SupplementalOil and Gas Disclosures (Unaudited)” to our consolidated financial statementsprovided herein.

 

As of December 31, 2008, we owned a 100%working interest in the Corvina Field, subject to Peruvian government royaltiesof 5% to 20% net revenue interest depending on the level of production. Theeffect of these royalty interest deductions is reflected in the calculation ofour net proved reserves. Our estimate of proved reserves have been preparedunder the assumption that our license contract will allow production for theexpected 30-year term for oil and 40-year term for gas, as more fully discussedunder “Description of Block Z-1” above.

 

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**Net ProvedCrude Oil Reserves and Future Net Cash Flows**

**As of December 31,2008**

**(ReservesQuantities in barrels)**

 
| ** **                                                                          | ** ** | **Actual** | ** **  |
|-------------------------------------------------------------------------------------|------------|------------|-------------|
| Proved Developed Producing                                                          |       | 4,223,398  |        |
| Proved Undeveloped                                                                  |       | 12,930,405 |        |
| Total Proved Reserves                                                               |       | 17,153,803 |        |
| Standardized Measure of Discounted Future  Net Cash Flows, Discounted @ 10% (PV-10) |       | $          | 298,926,934 |   |
|                                                                                     |            |            |             |  |

 

**Acreage**

 

The following table shows the number ofdeveloped and undeveloped acres as of December 31, 2008:

 
| ** **    | ** ** | **Acres** | ** ** |
|---------------|------------|-----------|------------|
| Developed     |       | 209       |       |
| Undeveloped   |       | 2,407,647 |       |
| Total acreage |       | 2,407,856 |       |

 

**Drilling Activity**

 

The following lists our successfulexploratory and development wells that were drilled during the year ended December 31,2008:

 
| **Corvina Field** | ** ** | **Exploratory/Development** | ** ** | **Drilling Depth  (feet)** | ** ** | **Date Objective  Drilled/Tested** | ** ** |
|------------------------|------------|-----------------------------|------------|---------------------------------|------------|-----------------------------------------|------------|
|                   |       |                        |       |                            |       |                                    |       |
| CX11-18XD              |       | Development                 |       | 8,792                           |       | 1st quarter                        |       |
| CX11-20XD              |       | Development                 |       | 9,800                           |       | 3rd quarter                        |       |

 

Drilling activity refers to the number of wells completed at any timeduring the fiscal year, regardless of when drilling was initiated. For thepurpose of this table, the term “completed” refers to the installation ofpermanent equipment for the production of oil or natural gas.

 

**Present Activities**

 

In November 2008, we commenced drillingon the CX11-15D well and reached total drilling depth in January 2009. TheCX11-15D targeted theknown oil and gas sands higher in the geological formation with the mainobjective of proving up a portion of the probable oil and gas reserves andgiving us another oil producing well. During the testing it was confirmed thatthe deeper prospective sands were found lower than expected and were locatedbelow the estimated oil-water contact, thus testing formation water. The testsin the upper oil zones resulted in no flow due to the quality of the sands inthis location. However, the gas sands in the gas zone were encountered higherthan expected, which should allow us to prove up some of the probable gasreserves. Operations have commenced to sidetrack the CX11-15D well, targeting alocation higher in the geological formation. Once the sidetrack is complete,which we estimate to be by the end of the first quarter, we will test theprospective oil sands which, in this location, should be above the oil-watercontact and of better quality. As part of the extended well testing program,the well will then be placed on production if commercial amounts of oil aretested. We anticipate production increases in the field based on the CX11-15Dwell being completed in late March. Management does not expect the results ofthis well to have a material impact on oil-in-place in Corvina.

 

Following the completion of the CX11-15D well inCorvina, we intend to work over the CX11-20XD well to maximize oil productionfrom the oil producing zone in the reservoir. The work over should be completedin approximately one month or less.

 

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We are producing oil under a long-term testingprogram, at the CX-11 platform in Corvina. Production for November and December 2008was approximately 140,000 and 148,000 barrels of oil, respectively, orapproximately 4,600 and 4,800 bopd, respectively. We were drilling the CX11-15Dwell in November and December 2008, which caused us to limitproduction during certain periods for safety reasons. In January 2009production has averaged approximately 4,600 bopd. We expect to continueincrease production when the CX11-15D well and future wells come online.

 

**Propertyin Ecuador**

 

Through our wholly-owned subsidiary, SMCEcuador Inc., a Delaware corporation, and its registered branch inEcuador, we also own a 10% non-operated working interest in an oil and gasproducing property, Block 2, located in the southwest region of Ecuador (the “SantaElena Property”). The Santa Elena Property is located west of the city ofGuayaquil along the coast of Ecuador. The license contract provides for royaltypayments equal to 23% of production. There have been almost 3,000 wells drilledin the field since production began in the 1920s. Currently, there areapproximately 1,250 active wells which produce approximately 1,600 barrels ofoil per day. The majority of the wells produce intermittently by gas lift,mechanical pump or swabbing techniques. Crude oil is gathered in holding tanksand pumped via pipeline to an oil refinery in the city of Libertad, Ecuador.The license agreement covering the property extends through May 2016.

 

**ITEM 3. LEGAL PROCEEDINGS**

** **

*Navy TankerLitigation*

 

The T/V SUPE,a small tanker owned and operated by the commercial division of the PeruvianNavy, caught fire and sank while under time charter to Tecnomarine, BPZExploración & Producción S.R.L’s marine contractor, resulting in twofatalities and numerous injuries. On December 18, 2008, a lawsuit wasfiled in the 152nd Judicial District Court of Harris County, Texas by twocrewmembers and the family and estate of two of the deceased sailors of the T/VSUPE against BPZ Energy, Inc. and BPZ Resources, Inc. As none of thePeruvian government sanctioned investigations into the SUPE incident foundfault on the part of Tecnomarine, BPZ or BPZ’s subsidiary, BPZ Exploración &Producción S.R.L., we do not currently believe based upon the known factsrelating to the incident that the outcome of the legal proceeding will have amaterial adverse effect on our financial condition, results of operations orcash flows. Additionally we believe the incident would be covered by ourinsurance policies, after a customary deductible.

 

**ITEM 4. SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS**

** **

There were no matterssubmitted to a vote of stockholders during the fourth quarter of the fiscalyear covered by this Form 10-K.

 

**PART II**

** **

**ITEM 5. MARKET FORREGISTRANT’S COMMON EQUITY, AND RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES**

** **

**Market Information**

** **

In October 2008, following theacquisition of the American Stock Exchange by the NYSE Euronext, our CommonStock began trading on the NYSE Alternext U.S. and our ticker symbol changed to“BPZ”. From January 12, 2007 until the merger, our Common Stock wastraded on the American Stock Exchange (“AMEX”) under the symbol “BZP”. Between December 27,2005 and January 12, 2007, our common stock was traded on the Pink Sheetsunder the symbol “BPZI.PK”.

 

The following table sets forth, for theperiods indicated, the high and low prices of a share of our Common Stock asreported on the NYSE Alternext U.S., AMEX and the Pink Sheets for theapplicable time periods. The quotations provided for the over the countermarket reflects interdealer prices without retail mark-up, mark-down orcommissions, and may not represent actual transactions.

 

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| ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| **2008**       |       |     |       |    |       |
| Fourth quarter |       | $        | 17.39      |    | $          | 3.95 |   |
| Third quarter  |       | 29.88    |       | 12.00   |       |
| Second quarter |       | 29.52    |       | 17.20   |       |
| First quarter  |       | 23.20    |       | 10.51   |       |
|           |       |     |       |    |       |
| **2007**       |       |     |       |    |       |
| Fourth quarter |       | $        | 13.08      |    | $          | 8.11 |   |
| Third quarter  |       | 7.84     |       | 4.14    |       |
| Second quarter |       | 7.55     |       | 5.58    |       |
| First quarter  |       | 6.00     |       | 3.61    |       |

 

**Holders**

 

As of February 23, 2009, we hadapproximately 168 shareholders of record, and an estimated 14,790 beneficialowners of our common stock.

 

**Wecurrently intend to retain all future earnings to fund the development andgrowth of our business. We have never paid cash or other dividends on ourstock. For the foreseeable future, we intend to retain earnings, if any, tomeet our working capital requirements and to finance future operations.Accordingly, we do not plan to declare or distribute cash dividends to theholders of our common stock in the foreseeable future. As of the date of thisfiling, we have not repurchased any of our equity securities and have notadopted a stock repurchase program.**

 

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**PerformanceGraph**

 

The following graph compares the cumulativetotal shareholder return for the Company’s Common Stock to that of (i) theRussell 2000 Stock Index, and (ii) a Company peer group of fiveindependent oil and gas exploration companies selected by us, for the periodindicated as prescribed by the SEC’s rules. The companies in our selected peergroup are Transmeridian Exploration, Inc., Contango Oil & Gas,Co, Harvest Natural Resources, Inc., Far East Energy Corp, and Carrizo Oil &Co Inc. “Cumulative total return” is defined as the change in share priceduring the measurement period, plus cumulative dividends for the measurementperiod (assuming dividend reinvestment), divided by the share price at thebeginning of the measurement period. The graph assumes $100 was invested on January 1,2003 in our Common Stock, the Russell 2000 Stock Index and a Company peergroup.

 

 

| ** **               | ** ** | **2003** | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| BPZ Resources, Inc. |       | $        | 100        |     | $          | 330      |       | $        | 370        |     | $          | 357      |       | $ | 972 |   | $ | 557 |   |
| Russell 2000 Stock Index |       | 100      |       | 116      |       | 120      |       | 140      |       | 136      |       | 89       |       |
| Peer Group Composite     |       | 100      |       | 138      |       | 188      |       | 240      |       | 429      |       | 272      |       |
|                          |            |          |            |          |            |          |            |          |            |          |            |          |            |  |  |  |  |  |  |

 

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**ITEM 6. SELECTEDFINANCIAL DATA**

 

The following selected financial informationshould be read in conjunction with “Management’s Discussion and Analysis ofFinancial Condition and Results of Operation” and the consolidated financialstatements and the notes thereto included under Item 8. — “FinancialStatements and Supplementary Data”.

 
| ** **                                                       | ** ** | **For the Year Ended December 31,** | ** **  |
|------------------------------------------------------------------|------------|--------------------------------------------------------------|-------------|
| ** **                                                       | ** ** | **2008**                                                     | ** **  | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operating Results:**                                           | ** ** | ** **                                                   | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue (net)                                                    |       | $                                                            | 62,954,901  |   | $ | 2,350,388 |   | $ | — |   | $ | — |   | $ | — |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Operating and administrative expenses:                           |       |                                                         |        |   |   |   |   |   |   |   |   |
| Lease operating expense                                          |       | 11,648,877                                                   |        | 754,833 |   | — |   | — |   | — |   |
| General and administrative                                       |       | 42,093,616                                                   |        | 18,548,465 |   | 11,531,864 |   | 5,805,226 |   | 8,915,192 |   |
| Geological, geophysical and engineering                          |       | 794,925                                                      |        | 4,045,381 |   | 2,048,742 |   | 998,131 |   | 360,965 |   |
| Depreciation, depletion and amortization                         |       | 16,061,540                                                   |        | 792,531 |   | 213,815 |   | 29,638 |   | 157 |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Total operating expenses                                         |       | 70,598,958                                                   |        | 24,141,210 |   | 13,794,421 |   | 6,832,995 |   | 9,276,314 |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Operating loss                                                   |       | (7,644,057                                                   | )           | (21,790,822 | ) | (13,794,421 | ) | (6,832,995 | ) | (9,276,314 | ) |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Other income (expense):                                          |       |                                                         |        |   |   |   |   |   |   |   |   |
| Income from investment in Ecuador property,  net of amortization |       | 717,571                                                      |        | 264,031 |   | 1,403,298 |   | 468,726 |   | 147,861 |   |
| Interest expense                                                 |       | —                                                       |        | — |   | (15,815 | ) | (11,149 | ) | (66,959 | ) |
| Amortization of deferred financing costs                         |       | —                                                       |        | — |   | — |   | (67,561 | ) | (360,439 | ) |
| Registration delay expense                                       |       | —                                                       |        | — |   | (3,552,513 | ) | (515,967 | ) | — |   |
| Interest income                                                  |       | 319,424                                                      |        | 854,905 |   | 787,455 |   | 509,808 |   | — |   |
| Merger costs                                                     |       | —                                                       |        | — |   | — |   | — |   | (5,470,455 | ) |
| Miscellaneous income (expense)                                   |       | 102,425                                                      |        | 200,904 |   | (315,463 | ) | 42,149 |   | 13,129 |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Total other income (expense)                                     |       | 1,139,420                                                    |        | 1,319,840 |   | (1,693,038 | ) | 426,006 |   | (5,736,863 | ) |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Loss before income taxes                                         |       | (6,504,637                                                   | )           | (20,470,982 | ) | (15,487,459 | ) | (6,406,989 | ) | (15,013,177 | ) |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Income taxes                                                     |       | 3,141,851                                                    |        | 39,001 |   | — |   | — |   | — |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Net loss                                                         |       | $                                                            | (9,646,488  | ) | $ | (20,509,983 | ) | $ | (15,487,459 | ) | $ | (6,406,989 | ) | $ | (15,013,177 | ) |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Basic and diluted net loss per share                             |       | $                                                            | (0.12       | ) | $ | (0.30 | ) | $ | (0.29 | ) | $ | (0.16 | ) | $ | (0.62 | ) |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Weighted average common shares outstanding                       |       | 77,389,536                                                   |        | 69,156,404 |   | 53,751,761 |   | 40,899,291 |   | 24,169,823 |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Oil sales price per barrel, net                                  |       | $                                                            | 76.23       |   | $ | 81.78 |   | $ | — |   | $ | — |   | $ | — |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| Operating cost per barrel produced                               |       | $                                                            | 14.11       |   | $ | 26.26 |   | $ | — |   | $ | — |   | $ | — |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**                                          |       |                                                         |        |   |   |   |   |   |   |   |   |
| Working Capital/(Defecit)                                        |       | $                                                            | (30,562,123 | ) | $ | 1,549,390 |   | $ | 22,057,206 |   | $ | 29,036,304 |   | $ | 3,611,410 |   |
| Property, equipment and construction in  progress, net           |       | 193,933,635                                                  |        | 100,366,091 |   | 38,726,910 |   | 4,365,040 |   | 5,505 |   |
| Total assets                                                     |       | 235,365,419                                                  |        | 129,619,204 |   | 74,036,726 |   | 38,090,980 |   | 5,161,095 |   |
| Total long-term debt                                             |       | 15,017,511                                                   |        | 15,537,293 |   | 55,815 |   | 70,908 |   | — |   |
| Stockholders’ equity                                        |       | 159,180,191                                                  |        | 90,740,112 |   | 63,635,905 |   | 36,731,577 |   | 4,586,155 |   |
|                                                             |       |                                                         |        |   |   |   |   |   |   |   |   |
| **Cash Flow Data:**                                              |       |                                                         |        |   |   |   |   |   |   |   |   |
| Cash flow provided by/(used in) operating activites              |       | 48,721,975                                                   |        | (15,170,838 | ) | (6,681,722 | ) | (4,461,328 | ) | (1,473,800 | ) |
| Cash flow used in investing activities                           |       | (102,185,451                                                 | )           | (58,463,949 | ) | (34,269,582 | ) | (5,745,130 | ) | (1,305,662 | ) |
| Cash flow provided by financing activities                       |       | 51,266,098                                                   |        | 55,824,742 |   | 36,820,407 |   | 35,647,397 |   | 6,785,497 |   |

 

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**ITEM 7. MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS**

 

*The following discussion andanalysis of our financial condition and results of operations should be read inconjunction with our audited consolidated financial statements and relatednotes contained elsewhere in this report. The following discussion includesforward-looking statements that reflect our plans, estimations and beliefs. Ouractual results could differ materially from those discussed in theseforward-looking statements. Factors that could cause or contribute to suchdifferences include, but are not limited to, those discussed below andelsewhere in this report.*

 

**Overview**

** **

We are an independent oil and gas companyfocused on the exploration, development and production of oil and natural gas inPeru and Ecuador. We also intend to utilize part of our planned future naturalgas production as a supply source for the complementary development of aCompany owned gas-fired power generation facility in Peru. We have theexclusive rights and license agreements for oil and gas exploration andproduction covering approximately 2.4 million acres in four blocks in northwestPeru and off the northwest coast of Peru in the Gulf of Guayaquil. We also owna 10% non-operated working interest in an oil and gas producing property, Block2, located in the southwest region of Ecuador (the “Santa Elena Property”).

 

We are in the initial stages of developingour oil and natural gas reserves and have begun producing oil and selling oilfrom the CX11 platform in the Corvina field of Block Z-1 under an extended welltesting program. Additionally, our activities in Peru include analysis andevaluation of technical data on our properties, preparation of the developmentplans for the properties, including detailed engineering and design of thepower plant and gas processing facilities, refurbishment of and designs forplatforms to be used under an extended well testing program, procuringmachinery and equipment for an extended drilling campaign, obtaining allnecessary environmental and operating permits, bringing additional productionon-line and securing the required capital and financing to conduct the currentplan of operation.

 

***Corvina Field***

 

Weare producing oil from our recent discoveries at the CX-11 platform, located inthe Corvina Field within the offshore Block Z-1, under an extended well testingprogram that started on November 1, 2007.  The Corvina field consistsof approximately 47,000 acres in water depths of less than 200 feet.  Weare currently concentrating our drilling efforts on West Corvina, whichconsists of 3,500 acres and have completed a total of four oil producing wells,the CX11-21XD, CX11-20XD, the CX11-18XD and the CX11-14D.  The oil isdelivered by barge to the Petroperu refinery in Talara, located approximately70 miles south of the platform.  Produced oil is kept in productioninventory until such time it is delivered to the refinery.

 

On October 24, 2007,Tecnomarine, our former primary marine transportation contractor, entered intotwo short-term time charterswith the commercial division of the Peruvian Navy to lease two small tankersfor use in our offshore oil production operation.  On January 30,2008, one of the tankers, the Supe, sank after catching fire.  At the timeof the incident, the tanker contained approximately 1,300 barrels of oil, mostof which burned in the fire. Official environmental impact assessmentsconcluded that environmental issues have been adequately controlled. On December 18,2008, a lawsuit was filed by two crewmembers and the family and estate of twoof the deceased crewmembers of the Supe against BPZ. As none of the Peruviangovernment sanctioned investigations into the Supe incident found fault on thepart of Tecnomarine, BPZ or the BPZ’s subsidiary, BPZ Exploración &Producción S.R.L., we do not currently believe based upon the known factsrelating to the incident that the claims asserted against us are meritoriousand intend to vigorously defend ourself. Additionally we believe the incidentwould be covered by our insurance policies, after a customary deductible. As a result of the incident, our operationswere voluntarily suspended at the CX-11 platform. For further informationregarding the civil claims asserted against us see Item 3. — “Legal Proceedings”.

 

OnMarch 14, 2008, we were notified by the OSINERGMIN, the governmentregulatory agency in Peru responsible for monitoring industrial safety, that wecould resume drilling and testing operations at the CX-11 platform allowing usto begin testing the CX11-18XD well.  Three drill stem tests wereconducted in the Upper Zorritos formation.  The first two drill stem teststargeted the lower sands in zones that had not previously been tested. The third drill stem test targeted sands that had tested oil in our CX11-21XDwell.  We began producing from the CX11-18XD well in May 2008 and, onJune 9, 2008 we received the clearance needed to transport oil from theCX-11 platform to the nearby Talara refinery by the corresponding Peruvianenvironmental agency.  In addition, our FPSO vessel was placed intoservice in the Corvina field and is currently being used in our extended welltesting program to process produced crude oil.

 

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Uponcompletion of the CX11-18XD well, we began drilling operations on the CX11-20XDwell in May 2008.  The CX11-20XD well is positioned higher up in thegeologic structure from the CX11-21XD well.  The well has been positionedto further develop the top gas sands found in the previously drilled CX11-21XDwell, the oil sands currently producing in the CX11-21XD and CX11-18XD wells,the oil sands encountered and briefly tested in the CX11-18XD well during theinitial drill-stem test number one, as well as sands found in the CX11-14Dwell.  The well tested positive for oil in quantities that we believe tobe commercially producible.  We completed two drill stem tests on foursets of oil sands in the well.  On November 1, 2008 we completed theCX11-20XD well as an oil-producing well under an extended well testing programcurrently ongoing at the Corvina field. However, because the well crosses sandswhich tested positive for what we believe to be economic quantities of gas,during the drilling and testing of both the CX11-21XD and CX11-18XD wells, weintend to re-complete the CX11-20XD well, with dual production strings, whengas is needed for the gas-to-power project, to allow the well to produce gas aswell as oil.

 

OnNovember 21, 2008, we began drilling operations on the CX11-15D welllocated in the Corvina field within the offshore Block Z-1 in northwest Peru.The CX11-15D targeted theknown oil and gas sands higher in the geological formation with the mainobjective of proving up a portion of the probable oil and gas reserves andgiving us another oil producing well. During the testing it was confirmed thatthe deeper prospective sands were found lower than expected and were locatedbelow the estimated oil-water contact, thus testing formation water. The testsin the upper oil zones resulted in no flow due to the quality of the sands inthis location. However, the gas sands in the gas zone were encountered higherthan expected, which should allow us to prove up some of the probable gasreserves. Operations have commenced to sidetrack the CX11-15D well, targeting alocation higher in the geological formation. Once the sidetrack is complete, inapproximately one month, we will test the prospective oil sands which, in thislocation, should be above the oil-water contact and of better quality. As partof the extended well testing program, the well will then be placed onproduction if commercial amounts of oil are tested. We anticipate increasedproduction based on the CX11-15D well being completed in late March.

 

As of December 31, 2008, we had four oilproducing wells, the CX11-21XD, CX11-20XD, the CX11-18XD and the CX11-14D underan extended well testing program. For 2009 we intend to keep the drilling rigat the CX-11 platform to focus on oil development in the offshore Block Z-1 andto drill three additional oil development wells to maximize cash flow.

 

***Albacora Field***

 

TheAlbacora field is located in the northern part of the offshore Block Z-1. Based on our internal models, we believe the Albacora field consists ofapproximately 6,000 acres and, like the Corvina field, is located in waterdepths of less than 200 feet. In 2009, once our second contracted drilling rig(the PTX18) has been mobilized to the Albacora A-1 platform, which is currentlybeing refurbished, we plan to drill the A-14XD well, a twin well to Albacora’s8-X-2 discovery well. The PTX18 rig is contracted with Petrex, our currentdrilling contractor, for a period of three years. This rig will be capable ofdrilling to approximately 14,000 feet, and will be modified to drill from anoffshore platform. This first well in Albacora will qualify as an exploratorywell as we plan on testing the prospective Lower Zorritos formationsands.  The 8-X-2 discovery well, drilled 35 years ago, tested oil and gasin the upper Zorritos formation sands at quantities we believe to becommercially producible.  Our drilling plans in Albacora field are todrill two new wells in 2009.

 

***Gas-to-Power Project***

 

TheCorvina gas-to-power project entails the installation of a 10-mile gas pipelinefrom the CX-11 platform to shore, construction of gas processing facilities andan approximately 135 megawatt (“MW”) simple-cycle electric generatingplant.  The proposed power plant site is located adjacent to an existingsubstation and power transmission lines which, with certain upgrades, areexpected to be capable of handling up to 360 MW of power. In order to supportour proposed electric generation project, we commissioned an independent powermarket analysis for the region. The Peruvian electricity market is deregulatedand power is transported through an interconnected national grid managed by theCommittee for Economic Dispatching of Electricity (known as “COES”). Based onthis study, we believe we will be able to sell economic quantities ofelectricity from the initial 135 MW power plant. The market study alsoindicates that there may be future opportunities for us to generate and sellsignificantly greater volumes of power into the Peruvian and possiblyEcuadorian power markets.  Accordingly, the revenues from the natural gasdelivered to the power plant will be derived from the sale of electricity. As aresult of factors outside our control, as further discussed below, we have postponeddevelopment of the gas-to power project until such time as we are able toobtain the necessary financing, personnel and equipment to continue theproject, including finding a joint venture partner to assist us in thegas-to-power project.

 

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*GE Turbine Purchase Agreement*

 

On September 26, 2008, we, through our powergeneration subsidiary, Empresa Eléctrica Nueva Esperanza, SRL, entered into a$51.5 million contract for the purchase of equipment and services (the “Agreement”)with GE Packaged Power, Inc. and GE International, Inc. Sucursal dePeru (collectively “GE”), which are part of GE Energy’s aeroderivative business. The Agreement obligates us to purchase three LM6000 gas-firedturbines. Each turbine will have a generation capacity of 45 megawatts,with excess capacity of approximately 5%.  Delivery of the three units wasinitially scheduled for the fourth quarter 2009.

 

In January 2009, as a result of our decision tofocus on increasing oil production, cash flow and reserves from the Corvina andAlbacora fields during 2009, we entered into an amendment to the Agreement withGE. Under the terms of the amendment, both GE and BPZ, agree to a suspensionperiod under the Agreement from and including December 15, 2008 through November 15,2009, whereby no failure on the part of BPZ or GE to perform any obligationsunder the Agreement will give rise to a breach of contract or give right toterminate the contract provided that we make milestone payment number four toGE in the amount of $3.4 million no later than February 25, 2009. As of February 24,2009, we paid $3.4 million related to milestone payment four to GE. In additionwe agreed to make milestone payment five in the amount of $3.5 million to GE nolater than November 16, 2009. Any failure to make these payments in fullwill result in immediate termination of the Agreement with no cure period ortime to correct the breach.

 

Once we decide to bring the Agreement out of thesuspension period, we will provide evidence that payment security has beenestablished and new delivery dates, pricing and payment terms will bedetermined by the BPZ and GE. All previous payments made by us on the Agreementwill be applied to the new price.

 

***Financing Activities***

 

*2009 Private Placement of Common Stock*

 

On February 13,2009, we announced our intent to sell approximately 15.7 million shares of ourcommon stock to institutional investors at a price of $3.05 per share for grossproceeds of approximately $48 million. On February 23, 2009, we closed aprivate placement of approximately14.3 million shares of common stock, no parvalue, to institutional and accredited investors pursuant to a Stock PurchaseAgreement dated February 19, 2009. Additionally, the IFC holds a right toelect to participate in the offering resulting in the possible sale of anadditional 1.4 million shares of common stock for a total of up toapproximately 15.7 million shares of common stock sold in this privateoffering. Thecommon stock was priced at $3.05 per share resulting in gross proceeds to us ofapproximately $43.6 million ($48.0 million if the IFC elects to participate inthe offering). Nowarrants or other dilutive securities were issued to the investors inconnection with the private placement. The shares were placed directly byPritchard Capital Partners, LLC and we have agreed to a 5% cash placement feeof the gross proceeds at each closing.  Additionally, we retained MorganKeegan & Company, Inc., as our financial advisor, in connectionwith the offering.  In return for its services, Morgan Keegan &Company, Inc. will receive an advisory fee of 1.5% of the gross proceedsof this transaction at each closing.

 

Underthe Stock Purchase Agreement, we committed to file a registration statementwith the SEC covering the shares no later than 45 days after the closing withrespect to such shares, and will use our reasonable best efforts to obtain theregistration statements effectiveness no later than the earlier of (i) 90days after the closing with respect to such shares, or in the event of SECreview of the registration statement, 120 days after the closing and (ii) thethird business day following the date on which we are notified (orally or inwriting, whichever is earlier) by the SEC that the registration statement willnot be reviewed or is no longer subject to further review and comment.  Weare subject to a potential maximum aggregate penalty of 13% of the grossproceeds of the offering or approximately $5.7 million, excluding the IFC’sparticipation, if the registration statement related to the offering is notfiled or declared effective within the time-frames outlined above.  At ouroption, any penalties would be payable in cash or our common stock.

 

Following theclosing of this private placement, we have 93,054,150 shares of common stockissued and outstanding, with fully diluted shares of 96,948,498, excluding the1.4 million shares the IFC may elect to purchase as part of the offering,respectively. Thefully diluted shares include the potential effect of vested and unvestedoptions and restricted stock outstanding.

 

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*$15.0Million IFC Reserve-Based Credit Facility*

 

 On August 15, 2008, we entered into a$15.0 million reserve-based lending facility (the “$15.0 million Senior Debt”)with IFC through our subsidiaries BPZ Exploración & Producción S.R.Land BPZ Marine Peru S.R.L as borrowers.  The $15.0 million Senior Debtrepresents the first tranche of an expected overall lending package ofapproximately $90.0 million.  We have primarily used the proceeds from theoffering for our initial $5.1 million down payment and subsequent monthlyprogress payments for the GE turbines (discussed above). For furtherinformation regarding the terms of the $15.0 million Senior Debt see “Liquidityand Capital Resources - $15 million IFC Reserve-Based Credit Facility” below.

 

*Reserve-BasedCredit Facility*

 

InAugust 2008, we signed a Mandate Letter and Facility Term Sheet withNatixis to underwrite and structure, on an exclusive basis, a $200.0 millionreserve-based credit facility. The $200.0 million reserve-based credit facilitywas approved by the Natixis Credit Committee in September 2008. Weoriginally planned to receive funding under the Natixis reserve-based creditfacility at the end of 2008 and planned to finance our ongoing oil developmentoperations and certain gas-to-power project costs**withthe proceeds until the receipt of the proceeds of the approximately $90.0million lending package with the IFC (discussed below)*.*Wealso planned to repay any advances from the $200.0 million reserve-based creditfacility used for the gas-to-power project from the IFC lending package oncethe project financing closed.

 

Subsequent to December 31, 2008, we finalized a revised MandateLetter and Facility Term Sheet with Natixis. Based on current credit andcommodity market conditions, Natixis has now resized the facility toapproximately $90.0 million inclusive of the $15.0 million tranche previouslyclosed and funded with the IFC, bringing the facility in line with the expectedborrowing base supported by our certified reserves. Once thefacility is closed, we expect the initial available borrowing capacity to beapproximately $60.0 million, inclusive of the $15.0 million already closed andfunded by IFC as described above”. The existing Natixis Credit Committee approval remains ineffect. The terms of the resized facility are expected to be aligned withrecent transactions in the market.

 

We expect tocomplete this financing in the first part of the second quarter of 2009.However, the closing of this tranche of the credit facility is dependent uponthe successful syndication of approximately 50% of the facility and successfulnegotiation of the related loan documents, and funding is predicated on thesatisfaction of certain conditions precedent as specified in the loandocuments. We cannot assure that the financing will occur early in the second quarter of2009 or at all. If we are unable to secure the financing with Natixis we willneed to find other funding sources to continue our operations. For further information regarding theexpected terms of the reserve-based credit facility see “Liquidity and CapitalResources” below.

 

*Gas-to-PowerProject Financing*

 

On November 29, 2006, a $120.0 millionfinancing package was approved by the Credit Committee of the IFC for thedevelopment of our gas-to-power project.  Originally, IFC intended to loan$50.0 million, of which $19.5 million was invested in our common stock in December 2006,with the remaining $70.0 million to be syndicated to other financialinstitutions.

 

However, the discovery of oil in the Corvinafield in early 2007 resulted in the gas-to-power project being deferred and ourdecision to focus on accelerating oil production.  As a result, the $30.5million balance of the IFC commitment was transferred to the oil developmentproject and funded as follows:  $15.5 million of convertible debt fundedin November, 2007 and converted into common stock in May, 2008 and $15.0million was funded in October, 2008 with the reserve based facility. See belowfor further information on $15.0 million credit facility.

 

We currently estimate the gas-to-powerproject will cost approximately $130.0 million.  The IFC has advised thatapproximately 65% of the project’s costs can be expected to be financed withtraditional project financing, given current market conditions. Accordingly, we have commenced discussions with potential joint venturepartners for the gas-to-power project in an attempt to secure additional equityfor the project.  Following the identification and selection of a partnerand consummation of project contracts, we will enter into negotiations with theIFC regarding restructuring the gas-to-power financing. We are expecting termsto include an eight year amortization of principal with interest rates toreflect the current market conditions at the time of closing along with typicalcovenants for this type of financing.  The closing of this financing,which is targeted for late 2009, will be subject to the satisfactorynegotiation of loan and security documents.

 

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*$15.5Million Debt Conversion to Equity*

 

In May 2008, we electedto exercise our option to convert $15.5 million of existing convertible debt with the IFC into approximately1.5 million shares of common stock. The terms of the Convertible DebtAgreement, dated November 19, 2007, stipulated a conversion price of$10.39 per share and included a forced conversion feature, exercisable at ouroption, if the closing price of the our common stock exceeds a price of $18.19per share based on the average closing price over a period of twentyconsecutive business days.

 

*EquityOffering*

 

OnMarch 25, 2008, we completed a public offering of 2.0 million shares ofcommon stock.  The offering was priced to the public at $20.00 per shareand underwritten by Canaccord Adams, Inc. (“Canaccord”) on a firmcommitment basis.  We received proceeds after underwriting fees anddiscounts of approximately $37.5 million.  In addition, we grantedCanaccord a 30-day option to purchase up to 200,000 additional shares to coverany over-allotments.  On April 18, 2008, the over-allotment optionwas executed and Canaccord bought an additional 200,000 shares resulting inproceeds to us after underwriting fees and discounts of approximately $3.6million.  A financial advisory fee of $150,000 was paid to Morgan Keeganfor investment services and consulting related to the offering.

 

*Conversionof Warrants*

 

At December 31, 2007, we had 250,000 warrants outstanding toMorgan Keegan & Company, Inc. for their role as placement agentin connection with the private placement of common stock in 2005 and for theirfinancial advisory services in connection with the private placement of commonstock in 2006. During the year ended December 31, 2008, MorganKeegan exercised the warrants to purchase 250,000 shares of our common stock atan exercise price of $3.00.  As a result, we received proceeds of $0.8million. The 2006 and 2005 warrants were valued at $0.2 million, and$0.3 million, respectively, using the Black-Scholes model, which was treated asadditional non-cash stock offering costs. At December 31, 2008, we had nooutstanding warrants.

 

*NotePayable*

 

In January 2009 in exchange of receipt of $1.0million from an individual (“Note Holder”), we signed a promissory note (the “Note”).The Notematures in July 2009 and bears an annual interest rate of 12.0%. Interestpayments are due monthly on the first day of each month the principal isoutstanding. Additionally the terms of the Note include a conversion feature,at our option, to deliver and exchange as consideration and payment of theNote; shares of our common stock. The number of shares will be determined byapplying a 12% discount to the closing price of our Common Stock on the dayprior to settlement. Further the Note Holder has the right to participate inany equity offering during the period the principal is outstanding by tenderingthe Note for shares of common stock. The number of shares will be determined bydividing the total outstanding indebtedness by the share price of the offeringon the same terms as other participants in the offering. Should we default onany terms of the Note, BPZ agrees to deliver our common stock, as considerationand payment of the Note, within 30 days the date of default.

 

*Memorandum of Understanding with Shell ExplorationCompany (West) B.V.*

 

On June 26, 2008, we entered into a Memorandum of Understanding (“MOU”)with Shell Exploration Company (West) B.V. (“Shell”). This non-binding MOUestablished the basis for both parties to move forward with negotiations for apossible joint venture agreement with the ultimate goal of jointly developingBlocks Z-1, XIX and XXIII in Northwest Peru into large-scale oil and gasventures, including regional power generation, gas supply for local andregional industry, and liquefied natural gas (“LNG”). Our purpose inconsidering forming a joint venture was to complement BPZ’s assets, localknowledge and experience, stakeholder relationships, and vision with Shell’stechnology, equipment, manpower and leadership, especially in gas marketing.

 

On January 9, 2009, BPZ and Shell mutuallyagreed to discontinue negotiations for a possible joint venture agreement ascontemplated by the MOU as certain complexities within the MOU could not bemutually agreed upon by both parties. BPZ will maintain its 100% workinginterest in Blocks Z-1, XIX, and XXIII, as well as Block XXII, which was notpart of the proposed transaction.

 

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*BPZ-02 EquipmentLease-Purchase*

 

InFebruary 2008, we entered into a lease-purchase agreement to acquire theBPZ-02 for approximately $7.0 million which represents the lesser of thepresent value of the minimum lease payments or the fair market value of theasset at inception of the lease.  The BPZ-02 is a deck barge approximately330 feet in length.  It will assist in the platform refurbishment anddrilling activities in the Albacora field as well as to assist in futureoffshore drilling and development activities.  The acquisition of theBPZ-02 allows us better asset maintenance scheduling and will aid in thesupport of increased offshore exploration and development activities.  Theterms of the lease-purchase stipulate a 19% rate of interest (33% effectiverate of interest) over a one-year term at which point, title to the BPZ-02 willtransfer to us upon final payment of the lease.  We are accounting for thetransaction as a capital lease in accordance to SFAS 13, “Accounting for Leases(As Amended)” (“SFAS 13”) and, as a result, depreciation will be recognizedover the economic life of the asset.

 

*ProductionEquipment Lease*

 

Weentered into a capital lease agreement for the production equipment used onboard the FPSO.  The FPSO, the Namoku, as well as the storage barge, theNu’uanu, are under a separate capital lease agreements.  The capital leasefor the production equipment commenced in June 2008, the date theequipment was put into service.  The lease bears an interest rate of 18%based on our incremental borrowing rate for similar equipment.  Inaccordance with the terms of the lease, a bargain purchase option exists at theend of the lease.  As a result, depreciation will be recognized over theeconomic life of the asset.  We recorded the capital lease at $2.4million, which represents the lesser of the present value of the minimum leasepayments or the fair market value of the asset at inception of the lease, inaccordance with the provisions of SFAS 13.

 

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**Future Market Trends and Expectations**

 

Our business depends primarily on the level of currentand future oil and gas prices and our ability to raise capital to finance thedevelopment of our current and future oil and gas opportunities, to continuedeveloping our gas-to-power project, which anchors our gas monetizing strategy,and to maintain our commitments and obligations under our current and futurelicense contracts. Currently markets for oil are depressed with spot oil pricesat or near a five year low. Additionally the U.S. banking sector is in disarrayprompting the federal government’s intervention to support the sector. Further,the economic slowdown in the U.S., combined with other factors, is negativelyinfluencing lending practices worldwide.

 

In response to the current environment, we havedecided to focus on oil development in Block Z-1, specifically the Corvina andAlbacora Fields, for 2009, and reduce operating and general and administrativeexpenses in an effort to enhance shareholder value by optimizing profits andpositioning ourselves for financing opportunities while continuing to work onraising additional capital to fund our existing and future oil and gasopportunities.

 

From a cost restructuring perspective, in December 2008,we implemented a cost restructuring initiative aimed at reducing general andadministrative expenses for Houston and Peru by 15% to 20% and overalloperating costs by as much as $1 million per month. Our initiative includesreducing personnel in Houston and Lima and senior management accepting salaryreductions up to 15% and foregoing year-end 2008 cash bonuses.

 

From a production perspective, our goal is to doubleour current daily production to 10,000 bopd at December 31, 2009. In orderto attain that goal we plan to commit a majority of our 2009 capital budget onappraising and developing oil in the Corvina and Albacora fields. Our drillingplans include drilling three additional oil development wells from the CX-11platform in the Corvina field and drilling two new wells in the Albacora fieldfrom a recently contracted rig that will be mobilized to the Albacora platform.

 

We believe the increased production from Corvina,combined with the cost restructuring, should allow us to be cash flow positivewhile drilling at Corvina and Albacora in 2010 while continuing to work closelywith IFC and Natixis on the reserve based revolvers, which are expected to havea sufficient borrowing base that, when added to cash flows from expectedCorvina and Albacora oil sales and the additional proceeds from the recent saleof our common stock, should cover the capital expenditures necessary to meetour 2009 capital needs. By focusing our efforts on oil development andproduction, implementing and executing our cost reduction initiative, whilecontinuing to work on additional financing, BPZ should succeed in a difficultcredit and volatile commodity pricing environment.

 

We anticipate future results will be based on ourproduction levels and current and future oil prices. When forecasting our 2009performance, we relied on assumptions about the market for oil, our customersand suppliers, and past results. We expect the average spot price for oil in2009 to be approximately $51.00 or 33% less than the average price we receivedin 2008. With our planned oil production increases, we expect earnings for 2009to slightly exceed that of 2008. Our results could materially differ from whatwe anticipate if any of our assumptions, such as commodity pricing, productionlevels or our ability to raise additional capital, prove to be incorrect. Inaddition, our businesses’ operations, financial condition and results ofoperations are subject to numerous risks and uncertainties that if realizedcould cause our actual results to differ substantially from our forward-lookingstatements. These risks and uncertainties are further described in Item 1A. — “RiskFactors” of this report.

 

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**Results ofOperations**

** **

***Year Ended December 31,2008 Compared to Year Ended December 31, 2007***

*** ***
| ** **                               | ** ** | **2008**   | ** ** | **2007**   | ** ** | **Increase/  (Decrease)** | ** ** |
|------------------------------------------|------------|------------|------------|------------|------------|---------------------------|------------|
| Net sales volume:                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                | ** ** |
| Oil and condensate (Bbls)                |       | 825,845    |       | 28,741     |       | 797,104                   |       |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                | ** ** |
| Net revenue:                             |       |       |       |       |       |                      |       |
| Oil and condensate                       |       | $          | 62,954,901 |       | $          | 2,350,388                 |       | $ | 60,604,513 |   |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                | ** ** |
| Average sales price:                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                | ** ** |
| Oil (per Bbl)                            |       | $          | 76.23      |       | $          | 81.78                     |       | $ | (5.55 | ) |
| ** **                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                | ** ** |
| Operating expenses                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                | ** ** |
| Lease operating expense                  |       | $          | 11,648,877 |       | $          | 754,833                   |       | $ | 10,894,044 |   |
| General and administrative               |       | 42,093,616 |       | 18,548,465 |       | 23,545,151                |       |
| Geological, geophysical and engineering  |       | 794,925    |       | 4,045,381  |       | (3,250,456                | )          |
| Depreciation, depletion and amortization |       | 16,061,540 |       | 792,531    |       | 15,269,009                |       |
| Total operating expenses                 |       | $          | 70,598,958 |       | $          | 24,141,210                |       | $ | 46,457,748 |   |
|                                     |       |       |       |       |       |                      |       |
| Operating loss                           |       | $          | (7,644,057 | )          | $          | (21,790,822               | )          | $ | 14,146,765 |   |

 

*Net Revenue*

 

Our2008 net revenue increased by $60.6 million to $63.0 million from $2.4 millionin 2007. The increase in net revenue is primarily due to increased oilproduction from the CX-11 platform located in the Corvina field within BlockZ-1 in northwest Peru. Oil production and revenues increased proportionatelycompared to 2007 primarily due to the increase in number of wells producing in2008 and the increase in production days. Partially offsetting the increase inproduction is an overall 7.0% decrease in average sales price received. In2007, we began producing oil on a limited basis in November 2007****from the CX11-21XD and CX11-14D wells inthe Corvina field under an extended well testing program.

 

Althoughour production increased in 2008 compared to 2007, we were not able to producefully during the year. During January 2008, we incurred production andtransportation delays due to the incident involving one of the Peruvian Navytankers being used in our offshore oil production operation as part of ourextended well testing program (see “Overview - Corvina Field” above for a moredetailed discussion of the incident). ** **As a result of the incident, our production was shut-in for approximately fivemonths while we completed a series of safety and integrity tests on thefacilities at the CX-11 Corvina platform and waited to receive the clearanceneeded to transport oil from the CX-11 platform to thenearby Talara refinery by the correspondingPeruvian environmental agencies.

 

Uponreceiving clearance to resume production and transportation in June 2008,we began production from our existing CX11-21XD and CX11-14D oil wells, as wellas bringing online the CX11-18XD oil well while only limiting production duringcertain periods by the drilling and testing of the CX11-20XD well. Productionof the CX11-20XD well began in the early part of the fourth quarter of 2008.Production from all four oil wells was limited during certain periods by thedrilling and testing of the CX11-15D oil well. On November 21, 2008, webegan drilling operations on the CX11-15D well in the Corvina field located inthe offshore Block Z-1 in northwest Peru. In January 2009, we reach totaldrilling depth and began testing the formation. During the testing it wasconfirmed that the deeper prospective sands that were found lower than expectedwere located below the estimated oil-water contact, thus testing formationwater. Operations have commenced to sidetrack the CX11-15D well, targeting alocation higher in the geological formation. Once the sidetrack is complete,which we expect to be by the end of the first quarter, we will test theprospective oil sands which, in this location, should be above the oil-watercontact and of better quality. As part of the extended well testing program,the well will then be placed on production if commercial amounts of oil aretested. We anticipate production increases in the field based on the CX11-15D wellbeing completed in late March.

 

Thenet revenues above exclude the cost of royalties owed to the government ofPeru. Royalties are calculated by Perupetro as stipulated in the Block Z-1license agreement based on the same Northwest Oil Basket.  However, their 

 

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calculation is based on thepast two week average price before the crude oil delivery date, as opposed tobeing based on the past five-day average price before the crude oil deliverydate. For the year ended December 31, 2008 and 2007, the revenues receivedby BPZ are net of royalty costs of approximately 5% of gross revenues or $3.3million and $0.1 million, respectively.

 

*Lease Operating*

 

Lease operating expenses include costs incurred to operate and maintainwells and related equipment and facilities. These costs include, among others,workover expenses, operator fees, processing fees, insurance and transportation.Lease operating expenses for 2008 increased $10.8 million to $11.6 million($14.11 per Bbl) from $0.7 million ($26.26 per Bbl) in 2007. The increase wasprimarily attributable to the production increases noted above. Additionally aswe had limited oil production during 2007 we also incurred limited leaseoperating expense for the same period. Typically, as production increases, ourlease operating expense per unit decreases as a result of fixed costs. Our 2008 lease operating expense includes approximately $38,000 related to thecost of the approximately 1,300 barrels of oil that was lost as a result of thetanker incident.

 

*General and Administrative*

 

General and administrative expenses areoverhead-related expenses, including employee compensation, legal, consulting and accounting fees, insurance,and investor relations expenses. General and administrative expenses for 2008increased $23.6 million to $42.1 million compared to $18.5 million in 2007. Theincrease in general and administrative expenses is primarily due to additionalemployees in Peru and increases in compensation expenses and legal feesincurred in 2008. In the third quarter of 2008 we internalized our previouslyoutsourced marine operations in order to better manage our long term growthinitiatives and tripled the number of our employees in Peru. Additionally weincurred increased personnel and compensation expense in order to administerour growth and to support our increased operations. Further we incurredadditional consulting and legal fees primarily as part of our negotiations withShell to explore jointly developing Blocks Z-1, XIX and XXIII in Northwest Peruinto large-scale oil and gas ventures. See Item 7. — “Memorandum of Understanding with Shell Exploration Company (West) B.V.”above for further information.**A subset of compensation expense, stock-basedcompensation expense increased by $11.5 million to $18.5 million in 2008 from$7.0 million in 2007. The increase is primarily a result of additional awardsgranted in the current year at the time when the price of our Common Stock washigh and therefore fair value of the awards and expense recognized increased asa result. Further, we recognized an additional $0.7 million of stock-basedcompensation expense, as compared to 2007, as a result of the acceleratedvesting for certain stock option awards.The awards granted under our 2007 Long-Term Incentive Plan and 2007 DirectorsCompensation Incentive Plan allows us to attract and retain key personnel.

 

*Geological, Geophysical and Engineering*

 

Geological,geophysical and engineering expenses include laboratory, environmental andseismic related expenses. Geological, geophysical and engineering expensesdecreased $3.3 million to $0.8 million in 2008 compared to $4.0 million in 2007.The decrease is primarily due to performing seismic activity in 2007 when weincurred 200 kilometers of 2-D seismic in Block XIX in order to comply with theprovisions of the related License Contract.

 

*Depreciation, Depletion and Amortization*

 

Depreciation,Depletion and Amortization (“DD&A”) expense increased $15.3 million during2008 to $16.1 million from $0.8 million for 2007. The DD&A expense increasewas due primarily to increased production discussed above. This amount includesapproximately $24,000 related to the cost of the approximately 1,300 barrels ofoil that was lost as a result of the tanker incident.

 

*OtherIncome/(Expense)*

 

Incomefrom our investment in Ecuador property increased $0.4 million to $0.7 millionin 2008 from $0.3 million in 2007. The increase is primarily due to increasedproduction and increased oil prices received in 2008.  Since ourinvestment consists of an interest in a producing oil and gas property, we areamortizing the investment on a straight-line basis over the remaining term ofthe license agreement covering the property.  Accordingly, we recordedannual amortization expense of $0.2 million for both 2008 and 2007.

 

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Forthe year ended December 31, 2008 and 2007, we capitalized interest expenseof $4.2 million and $1.2 million, respectively. The increase in capitalizedinterest expense is primarily related to our increased debt for the currentyear which includes interest on our capital lease obligations, $15.5 million ofIFC convertible debt, and $15.0 million Senior Debt.

 

Forthe year ended December 31, 2008 and 2007, we received interest income of$0.3 million and $0.9 million, respectively. The decrease in interest income isprimarily due to the increased cash balances in 2007 due to lower operatingexpenses.

 

Otherincome decreased $0.1 million to $0.1 million in 2008 from $0.2 million in2007. The decrease in other income is primarily due to a reduction in realizedforeign exchange rate gains of approximately $0.1 million in 2008. The exchangerate gain is primarily related to the early recovery of IGV or Value AddedTaxes in Peru.  IGV under the early recovery program is denominated in thePeruvian Nuevo Sol currency. The decrease in the net foreign currency gain wasdue to the strengthening of the Nuevo Sol against the US Dollar. See Item 7A. —“Quantitative and Qualitative Disclosures About Market Risk, *Foreign Currency ExchangeRate Risk”,* for a more detailed discussion.

 

Werecognized a total tax provision for the year ended December 31, 2008 ofapproximately $3.1 million compared to $39,000 for the same period in2007.  The difference is primarily due to oil sales from our production inBlock Z-1 during the 2008.  We are subject to Peruvian income tax on ourearnings at a statutory rate, as defined in the Block Z-1 License Contract, of22%.  Because we are under an extended well testing program, from which wewill finalize a development plan for Block Z-1, we have not moved into thecommercial phase of production as defined by the license contract.  Assuch, certain deductions are disallowed by the Peruvian tax regime while theCompany operates under the extended well testing program.  In addition,the tax provision amount is based on taxable Peruvian income that excludescertain U.S. expenses that are not deductible at the Peruvian level.  Thetax expense in 2007 is related to the revenues from our 10% non-operatedworking interest in the Santa Elena Property in southwestern Ecuador and itsaffect on our US non-consolidated returns.  We were unable to offset theoperating losses generated from our Peruvian branch with the revenues from ourEcuador branch.

 

The source of income (loss) before income taxexpense/ (benefit) for the year ended December 31, is as follows:

 
| ** **                                           | ** ** | **2008**   | ** **  | **2007**   | ** ** | **2006**    | ** ** |
|------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| United States                                        |       | $          | (28,121,651 | )          | $          | (12,922,310 | )          | $ | (11,627,018 | ) |
| Foreign                                              |       | 21,617,014 |        | (7,548,671 | )          | (3,860,441  | )          |
| Loss from continuing operations before  income taxes |       | $          | (6,504,637  | )          | $          | (20,470,981 | )          | $ | (15,487,459 | ) |

 

The income tax expense/(benefit) for the yearended December 31, 2008, 2007 and 2006 differs from the amount computed byapplying the U.S. statutory rate for the applicable year to consolidated netloss before taxes as follows:

 
| ** **                                                       | ** ** | **2008**   | ** ** | **2007**  | ** ** | **2006**   | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-----------|------------|------------|------------|
| Federal statutory income tax rate                                |       | $          | (2,211,576 | )         | $          | (7,139,493 | )          | $ | (5,242,737 | ) |
| Increases (decreases) resulting from:                            |       |       |       |      |       |       |       |
| Non-deductible stock compensation expense                        |       | 6,550,722  |       | 3,653,338 |       | —     |       |
| Tax effect of Peru conversion to permanent establishment  status |       | 7,642,249  |       | —    |       | —     |       |
| Change in domestic valuation allowance                           |       | (8,839,544 | )          | 3,525,156 |       | 5,242,737  |       |
|                                                             |       | $          | 3,141,851  |      | $          | 39,001     |       | $ | — |   |

 

Ournet loss decreased $10.9 million to ($9.6) million or ($0.12) per basic anddiluted share in 2008 from a net loss of ($20.5) million or ($0.30) per basicand diluted share during the same period in 2007. The decrease in net loss isprimarily due to the increase in oil revenues during 2008 compared with limitedoil revenues in 2007.

 

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***Year Ended December 31,2007 Compared to Year Ended December 31, 2006***

 
| ** **                               | ** ** | **2007**   | ** ** | **2006**   | ** ** | **Increase/  (Decrease)** | ** ** |
|------------------------------------------|------------|------------|------------|------------|------------|---------------------------|------------|
| Lease operating expense                  |       | $          | 754,833    | ** ** | **$**      | **—**                |       | $ | 754,833 |   |
| General and administrative               |       | 18,548,465 |       | 11,531,864 |       | 7,016,601                 |       |
| Geological, geophysical and engineering  |       | 4,045,381  |       | 2,048,742  |       | 1,996,639                 |       |
| Depreciation, depletion and amortization |       | 792,531    |       | 213,815    |       | 578,716                   |       |
| Total operating expenses                 |       | $          | 24,141,210 |       | $          | 13,794,421                |       | $ | 10,346,789 |   |
|                                          |            |            |            |            |            |                           |            |  |  |  |  |

 

Our operating and administrative expenses consisted principally ofgeneral and administrative costs as well as geological, geophysical andengineering costs.

 

Due to commencement of production from the CX-11 platform, we haveincurred lease operating expense of $0.7 million during the year ended December 31,2007 compared to no operating expenses incurred during the year ended December 31,2006. General and administrative costs have increased significantly from $11.5million during the year ended December 31, 2006 to $18.5 million duringthe year ended December 31, 2007 as a result of our increased activitylevels, necessary additional personnel and costs associated with being a publiccompany listed on the American Stock Exchange. Included in general andadministrative expense is stock-based compensation expense. Stock-basedcompensation expense for year ended December 31, 2007 was approximately$7.0 million compared to $3.2 million during the year ended December 31,2006. Stock based compensation expense is primarily related to our restrictedstock grants, accrued stock-based compensation under our 2007 Long-TermIncentive Plan and the recognition of Incentive Earn-out Stock Compensation fortwo of our executive officers, in the third quarter of 2007 due to theachievement of the entitlement to the right to production of not less than 2,000 barrelsof oil per day or its equivalent (approximately 12 million cubic feet of gasper day) prior to December 28, 2007. The overall increase was partiallyoffset by a reduction associated with unvested restricted stock grantsforfeited by certain employees who resigned from the Company during the yearended 2007. Weincurred $4.0 million of geological, geophysical and engineering costs duringthe year ended December 31, 2007 primarily related to the oil discovery inCorvina and to the continued development of our Corvina gas-to-power projectand 2-D seismic expense on Block XIX, compared to $2.0 million during the yearended December 31, 2006 primarily as a result of the commencement of ourCorvina gas-to-power project.

 

We received net cash distributions from our investment in Ecuadorproperty of $0.5 million during the year ended December 31, 2007, comparedto net cash distributions of $1.3 million during the year ended December 31,2006. The decrease in income primarily relates to capacity problems at thelocal refinery in Ecuador. As a result, oil sales for the year ended December 31,2007 were significantly less than for the year ended December 31, 2006.Since our investment consists of an interest in a producing oil and gasproperty, we are amortizing the investment on a straight-line basis over theremaining term of the license agreement covering the property. Accordingly, werecorded $0.2 million of amortization expense during each of the years ended December 31,2007 and December 31, 2006.

 

We incurred interest expense of $0.9 million during the year ended December 31,2007, all of which was capitalized to construction in progress, compared with$15,815 for the year ended December 31, 2006. The difference is primarilydue to interest associated with the purchase of two vessels under capital leaseobligation in 2007 compared to other debt related to acquiring furniture andfixtures during 2006.

 

We did not incur any registration delayexpense for the year ended December 31, 2007. During the year ended December 31,2006 we recorded registration delay expense totaling $3.6 million of whichapproximately $1.2 million was paid in cash and $2.3 million was settled by theissuance of 865,238 shares of common stock. In connection with the privateplacement of 11,466,000 common shares in July 2005, we were obligated toprepare and file with the SEC a Registration Statement on Form S-1 and touse our best efforts to cause the Registration Statement to be declaredeffective by the SEC no later than ninety days from closing. The RegistrationStatement had not been declared effective by the required date and we wereliable to the investors for liquidated damages in an amount equal to 1.0% ofthe purchase price of the shares, approximately $343,000, for each thirty dayperiod until the Registration Statement is declared effective by the SEC. Inaddition, in connection with the private placement of 4,482,000 common sharesin March 2006, we were obligated to prepare and file with the SEC aRegistration Statement on Form S-1 within ninety days from closing, and touse our best efforts to cause the Registration Statement to be declaredeffective by the SEC no later than ninety days, from March 8, 2006. TheRegistration Statement was not filed or declared effective by the requireddates and we were liable to the investors for liquidated damages in an amountequal to 1.0% of the purchase price of the shares, approximately $50,010, foreach thirty 

 

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day period until theRegistration Statement is declared effective by the SEC. On November 8,2006, the SEC declared effective the Registration Statement on Form S-1covering the common shares issued in connection with the July 19, 2005, March 10,2006, and June 30, 2006, private placements. As a result, we were nolonger subject to the liquidated damages described above.

 

As a result of our cash balances from the various private placements ofour common stock during 2005, 2006 and 2007, we received interest income of$0.9 million during the year ended December 31, 2007 and $0.8 millionduring the twelve months ended December 31, 2006.

 

We realized federal income tax expense of $39,001 during the year endedDecember 31, 2007. The tax is related to the revenues from our 10%non-operated working interest in the Santa Elena Property in southwesternEcuador. No tax expense was incurred during the year ended December 31,2006.

 

During the year ended December 31, 2007,we recognized a foreign exchange gain of approximately $0.2 million compared toapproximately $0.1 million during the year ended December 31, 2006. Thisis primarily as a result of our collection of Value Added Tax in Peru (“IGV”)under the early recovery program. IGV is denominated in local currency and thePeruvian Nuevo Sol has become stronger against the U. S. Dollar over the pastyear.

 

We realized a netloss of $20.5 million or $(0.30) per share during the year ended December 31,2007, compared to a net loss of $15.5 million or $(0.29) per share for the yearended December 31, 2006.

 

**Liquidity, Capital Resources and Capital Expenditures**

 

At December 31, 2008, we had cash and cash equivalents of $5.3million and current accounts receivable related to our December oil salesof $5.3 million, all of which was collected in early January 2009. We alsohad $12.1 million in Value Added Tax receivable which we will collect over timeas we invoice our oil sales.

 

At December 31, 2008, we had tradeaccounts payable and accrued liabilities of $45.0 million. Of this amount,approximately $10.0 million is over 60 days past due. In addition we have $6.8million in income tax and $1.9 million of profit sharing, as required underPeruvian law, due in April 2009. We also have capital lease obligationsprimarily related to the barges used in our marine operations of $7.8 million,all of which matures by end of 2009.

 

Our outstanding long-term debt at December 31,2008 consisted of a $15.0 million Reserve-Based Lending Facility bearinginterest at LIBOR plus 2.75% due December 31, 2012.

 
| ** **                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------|------------|--------------------------------------------|------------|
| **Cash Flows**         | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cash provided by (used in): |       |                                       |       |   |   |   |   |
| Operating activities        |       | $                                          | 48,721,975 |   | $ | (15,170,838 | ) | $ | (6,681,722 | ) |
| Investing activities        |       | (102,185,451                               | )          | (58,463,949 | ) | (34,269,582 | ) |
| Financing activities        |       | 51,266,098                                 |       | 55,824,742 |   | 36,820,407 |   |
|                             |            |                                            |            |  |  |  |  |  |  |  |

 

*Operating Activities*

 

Cashprovided by (used in) operating activities increased by $63.9 million to $48.7million in 2008 from $(15.2) million in 2007, respectively. Cash flow fromoperations increased due to higher oil production revenues during 2008 comparedto 2007, partially offset by higher operating and overhead costs. Cash flowbefore changes in operating assets and liabilities increased by$32.7 million reflecting the increase in production activity and changesin operating assets and liabilities provided a source of cash of $31.2 millionprimarily due to the increase in liabilities due to the incurring significantoperating costs near year end for the drilling, exploration, and development ofour CX11-20XD and CX11-15D wells and the timing of payments for those costs.

 

Cash used in operating activities increased by ($8.5)million to ($15.2) million in 2007 from $(6.7) million in 2006, respectively.Cash used in operations increased primarily due to higher operating costs ofour first wells, the CX11-21XD and CX11-14D, which began producing oil on alimited basis in November 2007. Cash flow before changes in operatingassets and liabilities decreased by ($2.9) million reflecting the increaseoperating activity and changes in operating assets and 

 

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liabilities provided a use ofcash of ($5.5) million primarily due to the increase in accounts receivable anddecrease in accounts payable as a result of our initial oil sales in the lasttwo months of 2007.

 

*Investing Activities*

 

Net cash used in investing activities increased by($43.7) million to ($102.2) million in 2008 from $(58.5) million in 2007,respectively, and is primarily due to increased capital expenditures in 2008.Net cash used in investing activities increased by ($24.2) million to($58.5) million in 2007 from $(34.3) million in 2006, respectively, and isprimarily due to increased capital expenditures and an increase in restrictedinvestments required in order to secure performance bonds under our licensecontracts.

 

*2008 Equipment Activity*

 

Duringthe year ended December 31, 2008, we incurred capital expenditures ofapproximately $110.6 million associated with our development initiativesfor the exploration and production of oil and natural gas reserves and thecomplementary development of proprietary gas-fired power generation ofelectricity for sale in Peru.

 

Ofthe incurred costs mentioned above, we incurred capital expenditures related tothe drilling and testing of the CX11-18XD, CX11-20XD and CX11-15D ofapproximately $19.0 million, $31.2 million, and $11.2 million, respectively,during the year ended December 31, 2008.

 

Wealso incurred costs of approximately $12.4 million during the year ended December 31,2008 for the installation of sea-bed pipelines and a new mooring system as aresult of placing the FPSO into service and production equipment to supportoperations.  This new program should enable us to initiate production in amore efficient manner which will allow for a better understanding of thebehavior and characteristics of the Corvina oil field.

 

Inpreparation for our drilling campaign in Albacora field, we performed wellcontrol on the existing well heads located at the A-1 platform.  Weincurred approximately $1.5 million in well control costs to provide a safeenvironment to its refurbishment.

 

Additionallyin 2008, we entered into two lease-purchase agreements to acquire the BPZ-02barge and to acquire the production equipment on board the Namoku resulting inadditional capital assets of approximately $7.0 million and $2.4 million,respectively. Further we capitalized an additional $2.8 million of productionequipment in order to have the FPSO ready to receive and treat oil receivedfrom the CX-11 platform.

 

Forthe development of a Company owned gas-fired power generation facility, weincurred costs of approximately $3.6 million related to the drafting of certaindesign specifications for the power plant and capitalized an additional $9.0million incurred as part of our agreement to purchase three LM6000 gas-firedturbines, including an initial down payment of $5.1 million.

 

Wealso incurred costs for office equipment and leasehold improvements for ouroffices in Houston, Peru and Ecuador of approximately $0.9 million and for thepurchase of machinery and equipment used in operations in Peru of approximately$0.7 million.

 

Forthe year ended December 31, 2008, in accordance with “successful efforts”method of accounting, we capitalized approximately $1.0 million of depreciationexpense, mainly related to the tender assist barges serving as supportequipment, and $4.2 million of interest expense to construction in progress.

 

*2007 Equipment Activity*

 

In August 2006, we incurred anoperational delay of approximately three weeks resulting from a navigationincident which caused the BPZ-01 barge to be grounded on a sand bank in TalaraBay in northwest Peru during the second mobilization trip to the Corvina CX-11platform. No injuries were sustained by any of our employees, nor to any of thetug boat operator’s crew members. The BPZ-01 is a U.S. flagged vessel and assuch was inspected after the incident by the U.S. Coast Guard, to itssatisfaction. The barge resumed normal operations immediately thereafter. Basedupon information currently available, we estimated that total expendituresrelated to this incident would be approximately $1.1 million. As of December 31,2006, approximately $0.4 million had been incurred for bargerecovery and temporary repairs to the vessel. In addition, we expect to incurapproximately $0.3 millionin permanent repairs to the barge and approximately $0.4 million of 

 

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consequential damages,primarily stand-by charges. As of December 31, 2008, a claim of approximately $0.8million for repairs is expected to be filed with the insurance carrier. A deductible of $75,000 will be applied tothis insurance claim when reimbursed.  We received proceeds from theunderwriter to cover a related claim regarding third party cargo that wasdamaged in the grounding incident. During the year ended December 31,2008, approximately $80,000 of insurance proceeds was received in connectionwith this claim.  A deductible of $25,000 was offset against the insuranceproceeds received.  This amount is unrelated to the $0.8 million hullclaim described above as the proceeds from the cargo claim were passed on tothe third party owner of the cargo that was damaged.  The hull claim willbe finalized upon the dry docking of the vessel.  Because of the delayscaused by the drilling of the highly deviated CX11-20XD well during the thirdquarter 2008, the dry dock of the BPZ-01 is scheduled during the last quarterof 2009.

 

In connection with the Block XIX licensecontract, we completed shooting 200 kilometers of 2-D seismic in 2007. The costto acquire this seismic data was approximately $3.6 million. Processing andinterpretation of the data was completed in late January 2008. Due to theflexibility under the license contract and as a result of our decision in 2008to focus on developing the Corvina and Albacora fields during 2009, wehave postponed our initial exploration of Block XIX to 2010.

 

On June 13, 2007, we entered into a capital lease agreement,with an option to purchase, for two barges to assist in the development of theCorvina oil. The two barges were towed to Peru where one barge, the Nu’uanu, isbeing used to transport oil between the CX11 platform and the refinery inTalara, approximately 70 miles south. The Nomoku is currently fitted with therequired equipment for its intended use as a FPSO and moored next to the CX11platform.

 

*Financing Activities*

 

Cash provided by financing activities decreased by ($4.6) millionto $51.3 million in 2008 compared to $55.8 million in 2007. This decrease incash provided by financing activities reflects increased cash used on principalpayments for capital lease obligations partially offset by additional cashproceeds from debt and proceeds received from the issuance of common stock.

 

Cash provided by financing activities increased by $19.0 millionto $55.8 million in 2007 compared to $36.8 million in 2006. This increase incash provided by financing activities reflects additional proceeds from the$15.5 million issuance of debt and proceeds received from the exercise of stockoptions.

 

*ShelfRegistration*

 

To finance our operations we may sell additionalshares of our common stock. Our certificate of formation does not provide forpreemptive rights. We currently have approximately $222 million in common stockavailable under an effective shelf registration statement, which we may sellfrom time to time in one or more offerings pursuant to underwritten publicofferings, negotiated transactions, block trades or a combination of these methods.

 

*$15.0Million IFC Reserve-Based Credit Facility*

 

On August 15, 2008, we entered into a $15.0 million reserve-basedlending facility (“$15.0million Senior Debt”)agreement (the “Loan Agreement”) with IFC through our subsidiaries BPZExploración & Producción S.R.L and BPZ Marine Peru S.R.L asborrowers.   The reserve-based lending facility matures in December 2012and bears interest at an approximate rate of LIBOR plus 2.75%, currentlyequivalent to 4.56% based on the current six month LIBOR rate of 1.81%. The maximum amount available under this facility will begin at $15.0 millionand will be reduced by $2.5 million beginning on December 16, 2010 andevery six months thereafter during the term of the Loan Agreement.  Theamount available under the Loan Agreement is subject to a semi-annual borrowingbase determination based on the value of oil reserves.  In addition, weare subject to various financial covenants calculated as of the last day ofeach quarter, including a life of field coverage ratio, life of loan coverageratio, debt to equity ratio and interest cover ratio. We were in compliancewith all applicable covenants of the Loan Agreement as of December 31,2008.  Funding for the initial amounts available under the Loan Agreement was subject to satisfying certain conditions precedentwhich were fulfilled on October 17, 2008 and subsequently BPZ borrowed theentire $15.0 million available under the Loan Agreement.

 

The Loan Agreement provides for events of default customary foragreements of this type, including, among other things, payment breaches underany of the finance documents for the first and second tranche of the seniordebt; failure to comply with obligations; representation and warranty breaches;expropriation of the assets, business or operations of any borrower;insolvencies of any borrower; certain attachments against the assets of anyborrower; failure to maintain certain authorizations with respect to anyfinancing documents with the IFC, the development and operation of the CorvinaField in

 

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Block Z-1, anyadditional petroleum assets under license contracts with Perupetro or certainother key agreements; revocation of any financing or security documents withthe IFC or certain key agreements; defaults on certain liabilities; certainjudgments against the borrower or any subsidiary; abandonment or extendedbusiness interruption of the Corvina Field or certain other petroleum assets;engagement in certain sanctionable practices; or restrictions are enacted inPeru that could inhibit any payment a borrower is required to make under thefinancing documents with the IFC.

 

If an event of default occurs, IFC and any additional facility agentmay (i) terminate all or part of the relevant facility; (ii) declareall or part of the principal amount of the loan, together with accruedinterest, immediately due and payable;  (iii) declare all or part ofthe principal amount of the loan, together with accrued interest, payable ondemand; or (iv) declare any and all of the security documents under thefacility enforceable and exercise its rights under such documents. In addition,if any borrower is liquidated or declared bankrupt, all loans and interestaccrued on it or any other amounts due, will become immediately due and payablewithout notice.

 

*Performance Bonds*

 

Asof December 31, 2008, we had restricted cash deposits of $5.1 million,which partially collateralizes the insurance and performance bonds. Inconnection with our properties in Peru, we have obtained four performance bondstotaling $5.3 million that are partially collateralized by restricted cashdeposits of $2.9 million to insure certain performance obligations andcommitments under the license contracts for Blocks Z-1, XIX, XXII and XXIII.Additionally we have $2.2 million of restricted cash to collateralize insurancebonds for import duties related to the FPSO and transport tanker.

 

Duringthe year ended December 31, 2008, we were refunded $0.8 million from aperformance bond related to the second exploration phase under the Block XIXlicense contract and approximately $1.0 million related to a performancecommitment under a drilling services contract.

 

Allof the performance bonds are issued by Peruvian banks and their terms aregoverned by the corresponding license contract.

 

*2009 Project Capital Budget*

* *

We established a 2009 capital expenditures budget of approximately$86.0 million and intend to focus our efforts on oil production in Block Z-1 bycommitting amajority of our capital expenditures budget to appraise and develop the oil inthe Corvina and Albacora fields. Accordingly,we have decided to keep the rig currently drilling at the CX-11 platform inplace to drill three additional oil development wells in 2009 to maximize cashflow. Additionally, the recently contracted rig scheduled for onshore BlockXIX, will instead be mobilized to the platform near the Albacora field to drilltwo new wells beginning in the third quarter of 2009. The goal under thisdevelopment plan is to increase total production at the end of 2009 to 10,000barrels of oil per day (bopd).

 

Due to the flexibility of the license contracts inPeru, we intend to delay the exploration of Block XIX to 2010. We believe theincreased production from the Corvina field, combined with cost restructuring,will allow us to be cash flow positive while drilling at the Corvina andAlbacora fields. Additionally we are continuing to work with the IFC andNatixis on the reserve based credit facility which is expected to have aborrowing base sufficient that, when added to cash flow from expected Corvinaand Albacora field oil sales and recent sale of our common stock, should coverthe capital expenditures noted below.

 

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| ** **                          | ** ** | **2009 Capital  Budget** | ** ** |
|-------------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **($ in millions)** | ** ** |
| **Corvina**                         |       |                          |       |
| CX11-15D drillling and testing      |       | $                             | 11.0       |   |
| CX11-19D development and production |       | 10.0                          |       |
| CX11-22D development and production |       | 10.0                          |       |
| CX11-23D initial drilling           |       | 5.0                           |       |
| Other facilities and activities     |       | 7.0                           |       |
|                                |       | 43.0                          |       |
| **Albacora**                        |       |                          |       |
| A-14XD exploration and development  |       | 15.0                          |       |
| A-15XD exploration and development  |       | 15.0                          |       |
| Other facilities and activities     |       | 11.0                          |       |
|                                |       | 41.0                          |       |
|                                |       |                          |       |
| **Other activities**                |       | 2.0                           |       |
| Total estimated capital budget      |       | $                             | 86.0       |   |

 

*Liquidity Outlook*

* *

Our 2008 net revenue increased by $60.6 million to$63.0 million from $2.4 million in 2007. The increase in net revenue isprimarily due to increased oil production from the CX-11 platform located inthe Corvina field in Block Z-1 in northwest Peru. Oil production and revenuesincreased proportionately compared to 2007 primarily due to the increase innumber of wells producing in 2008 and the increase in production days.

 

Our major sources of funding to date havebeen through oil sales, equity raises and, to a lesser extent, debt financingactivities. With our current cash balance, proceeds from the expected IFC andNatixis debt facilities, current and prospective Corvina and Albacora Oildevelopment cash flow, other potential third-party financing and potentialfinancing from future equity raises, we believe we will have sufficient capitalresources to execute our current Corvina and Albacora oil development projectsas well as service our current debt obligations and plan to continue pursuingour gas-to-power project once project funding becomes available. However, thetiming and execution of our project is dependent on a variety of factors,including the technical design of facilities, permitting approval, availabilityof equipment, time and costs required for delivery of materials andconstruction operations, performance by contractors and the success of plannedfinancing, many of which factors are outside our control and cannot be assured.

 

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**Off-Balance Sheet Arrangements**

** **

Asof December 31, 2008, we had no transactions, agreements or othercontractual 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.

 

**Contractual Obligations**

 
| ** **                     | ** ** | **Payments Due by Period at December 31, 2008** | ** ** |
|--------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                     | ** ** | ** **                                                                         | ** ** | **Less Than** | ** ** | **One to** | ** ** | **Three to** | ** ** | **More Than** | ** ** |
| ** **                     | ** ** | **Total**                                                                          | ** ** | **One Year** | ** ** | **Three Years** | ** ** | **Five Years** | ** ** | **Five Years** | ** ** |
| **Contractual Obligations:**   |       |                                                                               |       |   |   |   |   |   |   |   |   |
| Operating lease obligation (1) |       | $                                                                                  | 5,855,320  |   | $ | 950,847 |   | $ | 1,934,376 |   | $ | 2,069,974 |   | $ | 900,123 |   |
| Capital lease obligation (2)   |       | $                                                                                  | 10,513,061 |   | $ | 10,495,013 |   | $ | 18,048 |   | $ | — |   | $ | — |   |
| Debt obligation (3)            |       | $                                                                                  | 17,166,950 |   | $ | 684,300 |   | $ | 8,697,525 |   | $ | 7,785,125 |   | $ | — |   |
| Purchase obligation (4)        |       | $                                                                                  | 42,887,500 |   | $ | 6,939,143 |   | $ | 35,948,357 |   | $ | — |   | $ | — |   |
| Total                          |       | $                                                                                  | 76,422,831 |   | $ | 19,069,303 |   | $ | 46,598,306 |   | $ | 9,855,099 |   | $ | 900,123 |   |

 

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(1)               Includes operating leases for our executiveoffice in Houston, Texas, and our branch offices in Lima, Peru. In 2008, bothour Houston office and Lima offices entered into agreements for additionaloffices space of 7,070 square feet and 22,500 square feet expiring 2016 and2013, respectively.

 

(2)               Includes capital lease for two production andstorage barges which began in August 2007 and is set to expire in November 2009.Lease payments are variable based on the working status of the barges, with apurchase option of $5,000,000 after the first year of the lease and $4,000,000after the maturity date of the lease. Also, includes lease-purchase of theBPZ-02 which stipulates a 19% rate of interest (33% effective rate of interest)over a one-year term at a fixed rate of payment of $694,167. At the end of theterm, title to the BPZ-02 will transfer to us upon final payment of the lease.In addition, includes the $2.4 million capital lease of the productionequipment onboard the Floating Production Storage and Offload Facility, theNamoku. The lease terms are variable and bear an interest rate of 18% based onour incremental borrowing rate for similar equipment. In accordance with theterms of the lease, a bargain purchase option exists at the end of the lease.Finally, includes the capital lease for office furniture in our executiveoffice in Houston, Texas expiring in 2010.

 

(3)               Includes the debt and interest paymentsrelated to the $15.0 million reserve-based lending facility agreement with IFCthrough our subsidiaries BPZ Exploracion & Produccion S.R.L and BPZMarinePeru S.R.L as borrowers.  Theinterest used is an approximate rate of LIBOR plus 2.75%, currently equivalentto 4.56% based on the current six month LIBOR rate of 1.81%.  The maximum amount available under thisfacility will begin at $15.0 million and will be reduced by $2.5 millionbeginning on December 16, 2010 and every six months thereafter during theterm of the Loan Agreement.

 

(4)               The amount relates to the purchase of threeLM6000 gas-fired turbines from GE for $51.5 million.  Due to the amendment, the lease paymentsinclude the required payments due in 2009 and the remaining balance under theoriginal lease agreement in 2010. However, both GE and BPZ have agreed to determine new delivery dates,pricing and payment terms when we decide to bring the lease-purchase out of thesuspension period.

 

**Critical Accounting Policies**

 

The discussion and analysis of our financialcondition and results of operations is based on our consolidated financialstatements, which have been prepared in accordance with U.S. generally acceptedaccounting principles (“GAAP”). Management uses estimates and assumptions inpreparing the consolidated financial statements in accordance with GAAP. Thoseestimates and assumptions affect the reported amounts of assets, liabilities,revenues and expenses in the consolidated financial statements, and thedisclosure of contingent assets and liabilities. We have identified thefollowing as critical accounting policies directly related to our business andoperations, and the understanding of our financial statements.

 

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***Successful Efforts Method of Accounting***

 

We follow the successful efforts method ofaccounting for our investments in oil and gas properties. Under this method,oil and gas lease acquisition costs and intangible drilling costs associatedwith exploration efforts that result in the discovery of proved reserves andcosts associated with development drilling, whether or not successful, arecapitalized when incurred. Certain costs of exploratory wells are capitalizedpending determinations that proved reserves have been found. If thedetermination is dependent upon the results of planned additional wells andrequired capital expenditures to produce the reserves found, the drilling costswill be capitalized 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 well. All costs related tounsuccessful exploratory wells are expensed when such wells are determined tobe non-productive or at the one year anniversary of completion of the well ifproved reserves have not been attributed and capital expenditures as describedin 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 effortsmethod of accounting requires management’s judgment to determine the properdesignation of wells as either developmental or exploratory, which willultimately determine the proper accounting treatment of the costs incurred. Theresults from a drilling operation can take considerable time to analyze, andthe determination that commercial reserves have been discovered requires bothjudgment and application of industry experience. Wells may be completed thatare assumed to be productive and actually deliver oil and gas in quantitiesinsufficient to be economic, which may result in the abandonment of the wellsat a later date. The evaluations of oil and gas leasehold acquisition costsrequires management’s judgment to estimate the fair value of exploratory costsrelated to drilling activity in a given area.

 

The successful efforts method of accountingcan have a significant impact on the operational results reported when we entera new exploratory area in hopes of finding oil and gas reserves. Seismic costscan be substantial, which will result in additional exploration expenses whenincurred. The initial exploratory wells may be unsuccessful and the associatedcosts will then be expensed as dry hole costs, and any associated leaseholdcosts may be impaired.

 

***Revenue Recognition***

 

The Company does not recognize revenues until theyare realized or realizable and earned. Revenues are considered realized orrealizable and earned when: (i) persuasive evidence of an arrangementexists, (ii) delivery has occurred or services have been rendered, (iii) theseller’s price to the buyer is fixed or determinable and (iv) collectabilityis reasonably assured.

 

The Company sells its production in thePeruvian domestic market on a contract basis. Revenue is recorded net ofroyalties when the purchaser takes delivery of the oil. At the end of theperiod, oil that has been produced but not sold is recorded as inventory at thelower of cost or market. Cost is determined on a weighted average based onproduction costs.

 

***Impairment of Long-Lived Assets***

 

We periodically evaluate the recoverabilityof the carrying value of our long-lived assets and identifiable intangibles bymonitoring and evaluating changes in circumstances that may indicate that thecarrying amount of the asset may not be recoverable. Examples of events orchanges in circumstances that indicate the recoverability of the carryingamount of an asset should be assessed include, but are not limited to, (a) asignificant decrease in the market value of an asset, (b) a significantchange in the extent or manner in which an asset is used or a significantphysical change in an asset, (c) a significant adverse change in legalfactors or in the business climate that could affect the value of an asset oran adverse action or assessment by a regulator, (d) an accumulation ofcosts significantly in excess of the amount originally expected to acquire orconstruct an asset, and/or (e) a current period operating or cash flowloss combined with a history of operating or cash flow losses or a projectionor forecast that demonstrates continuing losses associated with an asset usedfor the purpose of producing revenue.

 

We consider historical performance andanticipated future results in our evaluation of potential impairment.Accordingly, when indicators of impairment are present, we evaluate 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.

 

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***Future Dismantlement, Restoration, andAbandonment Costs***

 

The accounting for future development andabandonment costs changed on January 1, 2003, with the issuance ofStatement of Financial Accounting Standards (“SFAS”) No. 143, “Accountingfor Asset Retirement Obligation” (“ARO”), which requires the fair value of a liabilityfor an asset retirement obligation to be recognized in the period in which itis incurred if a reasonable estimate of fair value can be made. The associatedasset retirement costs are capitalized as part of the carrying amount of thelong-lived asset. The accrual is based on estimates of these costs for each ofour properties based upon the type of production structure, reservoircharacteristics, depth of the reservoir, market demand for equipment, currentlyavailable procedures and consultations with construction and engineeringconsultants. Because these costs typically extend many years into the future,estimating these costs is difficult and requires management to make estimatesand judgments that are subject to future revisions based on numerous factors,including changing technology, the political and regulatory environment andestimates as to the proper discount rate to use and timing of abandonment.

 

Our plan of operationsincludes the drilling of wells and the construction of an electric powergeneration plant. We will be required to plug and abandon those wells andrestore the well sites and power generation site upon abandonment if they areabandoned prior to the end of the contract period. See Note 8 “Asset RetirementObligation” to the consolidated financial statements provided herein forfurther detail.

 

***Principles ofConsolidation***

*** ***

Our consolidatedfinancial statements include the accounts of the Company and its wholly-ownedsubsidiaries and branch offices. All intercompany balances and transactionshave been eliminated.

 

Our accountingpolicy regarding partnership or joint venture interests in oil and gasproperties is to consolidate such interests on a pro-rata basis in accordancewith accepted practice in the oil and gas industry. However, we have not beenable to receive timely information to allow us to proportionately consolidatethe minority non-operated working interest owned by our consolidatedsubsidiary, SMC Ecuador Inc. See Note 6 “Investment inEcuador Property” to the consolidated financial statements for furtherdiscussion regarding the investment in our Ecuador property. Accordingly, weaccount for this investment under the cost method. As such, we record our shareof cash received or paid attributable to this investment as other income orexpense.

 

***Foreign Exchange***

*** ***

The U.S. Dollar is thefunctional currency for our operations in both Peru and Ecuador. Ecuador hasadopted the U.S. Dollar as its official currency. Peru, however, still uses itslocal currency, Nuevo Sol, in addition to the U.S. Dollar and therefore ourfinancial results are subject to favorable or unfavorable fluctuations in theexchange rate and inflation of that country. We have adopted SFAS No. 52, “ForeignCurrency Translation,” which requires that the translation of the applicableforeign currency into U.S. dollars be performed for balance sheet monetaryaccounts using current exchange rates in effect at the balance sheet date,non-monetary accounts using historical exchange rates in effect at the time thetransaction occurs, and for revenue and expense accounts using a weightedaverage exchange rate during the period reported. Accordingly, the gains orlosses resulting from such translation are included in other income and expensein the consolidated Statements of Operations.

 

**Recent Accounting Pronouncements**

 

OnDecember 31, 2008 the SEC adopted the final rules regardingamendments to current Oil and Gas reporting requirements. The amendments aredesigned to modernize and update the oil and gas disclosure requirements toalign them with current practices and changes in technology and include thefollowing:

 

·                  Requiring companies to report oiland gas reserves using an average price based upon the prior 12-monthperiod-rather than year-end prices.

·                  Enabling companies to additionallydisclose their probable and possible reserves.

·                  Requiring previously nontraditionalresources, such as oil shales, to be classified as oil and gas reserves if thenontraditional resources are intended to be upgraded to synthetic oil and gas.

·                  Requiring companies to report theindependence and qualifications of a preparer or auditor, based on currentSociety of Petroleum Engineers criteria.

·                  Requiring the filing of reports forcompanies that rely on a third party to prepare reserves estimates or conduct areserves audit.

 

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·                  Permitting the use of newtechnologies to determine proved reserves if those technologies have beendemonstrated empirically to lead to reliable conclusions about reservesvolumes.

 

Theamendments are effective for registration statements filed on or after January 1,2010, and for annual reports on Forms 10-K and for fiscal years ending on orafter December 31, 2009. Early adoption is not permitted in either annualor quarterly reports before the first annual report in which the reviseddisclosures are required. The Company is currently evaluating the impact of theamendments on its consolidated financial position, results of operations andcash flows.

 

Inaddition, in May 2008, the FASB issued SFAS No. 162, “The Hierarchyof Generally Accepted Accounting Principles”, which identifies the sources ofaccounting principles and the framework for selecting the principles used inthe preparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles(GAAP) in the United States of America. This statement is effective60 days following the SEC’s approval of the Public Company AccountingOversight Board amendments to AU Section 411, “The Meaning of PresentFairly in Conformity with Generally Accepted Accounting Principles.” TheCompany does not expect the adoption of SFAS No. 162 to have a materialimpact on its consolidated financial position, results of operations or cashflows.

 

Alsoin June 2008, the FASB issued Financial Staff Position (“FSP”) No. FSPEITF 03-6-1 “Determining Whether Instruments Granted in Share-Based PaymentTransactions Are Participating Securities,” (“FSP EITF 03-6-1”), which providesthat unvested share-based payment awards that contain nonforfeitable rights todividends or dividend equivalents (whether paid or unpaid) are participatingsecurities and, therefore, need to be included in the earnings allocation incomputing earnings per share under the two class method. FSP EITF 03-6-1 iseffective for us on January 1, 2009 and all prior-period EPS data(including any amounts related to interim periods, summaries of earnings andselected financial data) will be adjusted retroactively to conform to itsprovisions. Early application of FSP EITF 03-6-1 is not permitted. On January 1,2009, we adopted the provisions of FSP EITF 03-6-1 and the adoption, althoughour restricted stock awards meet this definition, did not have a significantimpact on our reported earnings per share.

 

**ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The primary objective of the followinginformation is to provide forward-looking quantitative and qualitativeinformation about our potential exposure to market risks. The term “market risk”refers to the risk of loss arising from adverse changes in interest rates, oiland natural gas prices and foreign currency exchange rates. The disclosures arenot meant to be precise indicators of expected future losses, but ratherindicators of reasonable possible losses. This forward-looking informationprovides indicators of how we view and manage our ongoing market riskexposures. All of our market risk sensitive instruments were entered into forpurposes other than speculative trading.

 

*InterestRate Risk.*

 

Asof December 31, 2008, we had long-term debt and capital lease obligationsof approximately $15.0 million and current maturities of long-term debt andcapital lease obligations of approximately $7.8 million, consisting of threecapital lease obligations for two barges and production equipment and two loansfor office furniture.

 

The$15.0million reserve-based lending facility is variable rate debt and bears interestat an approximate rate of LIBOR plus 2.75%. The variable rate debt exposes us to the risk of increased interestexpense in the event of increases in short-term interest rates. If the variableinterest rate were to increase by 1% from December 2008 levels, interestexpense would increase by approximately $0.2 million annually. Thecarrying value of the variable interest rate debt approximates fair value as itbears interest at current market rates.

 

Thefirst capital lease obligation is for the FPSO barges which began in August 2007and is set to expire in November 2009. Lease payments are variable basedon the working status of the barges, with a purchase option of $5,000,000 afterthe first year of the lease and $4,000,000 after the maturity date of thelease.  The capital lease obligation has an imputed interest rate of18.00% over a lease term.  The second capital lease obligation contains alease-purchase option and stipulates a 19% rate of interest (33% effective rateof interest) over a one year term, at which point title to the BPZ-02 will transferto us upon final payment of the lease.  The third capital lease obligationis for the production equipment on board the FPSO barge, the Namoku, andcontains a purchase option at the end of twelve months and stipulates aninterest rate of 18.0%.  We have two additional loans for office equipmentcontaining a term of 60 months and bearing fixed interest rates of 5.94% and9.44%, respectively, with principal and interest payments due on a monthlybasis.

 

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Wedo not expect a significant change in the market interest rate to impact theinterest on our term debt.  However, significant changes in marketinterest rates may significantly affect the level of financing that the IFCwill structure with respect to our project in Peru.

 

*CommodityPrice Risk.*

 

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.  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 widefluctuations in response to relatively minor changes in supply of and demandfor oil and gas, market uncertainty, and a variety of additional factors thatare beyond our control.

 

Loweroil and natural gas prices may not only decrease our revenues on a per unitbasis, but may also reduce the amount of oil and natural gas we can produceeconomically, if any.  A substantial or extended decline in oil andnatural gas prices may materially affect our future business, financialcondition, results of operations, liquidity and borrowing capacity, and we mayrequire a reduction in the carrying value of our oil and gas properties. While our revenues may increase if prevailing oil and gas prices increasesignificantly, exploration and production costs and acquisition costs foradditional properties and reserves may also increase.

 

Withrespect to our planned electricity generation business, the price we can obtainfor the sale of power may not rise at the same rate, or may not rise at all, tomatch a rise in the Company’s cost to produce and transport gas reserves to ourinitial 135MW power plant in Caleta Cruz.  Prices for both electricity andnatural gas have been very volatile in the past year and have increasedsignificantly over the past two years.  The profitability of this businessdepends in large part on the difference between the price of power and the priceof fuel used to generate power, or “spark spread.”

 

*ForeignCurrency Exchange Rate Risk.*

 

The U.S. Dollar is the functional currency for ouroperations in both Peru and Ecuador.  Ecuador has adopted the U.S. Dollaras its official currency.  Peru, however, uses its local currency, NuevoSol, in addition to the U.S. Dollar, and therefore, our financial results aresubject to favorable or unfavorable fluctuations in the exchange rate andinflation in that country.  Transaction differences have been nominalto-date but are expected to increase as our activities in Peru continue toescalate.  During the year ended December 31, 2008, 2007 and 2006 werecognized exchange rate gains of approximately $0.1 million, $0.2 million and$0.1 million, respectively.  The exchange rate gains are primarily relatedto the early recovery of IGV or Value Added Taxes in Peru.  IGV under theearly recovery program is denominated in the Peruvian Nuevo Sol currency. However, the total gain during 2008 was partially offset by Nuevo Soldenominated accounts payable being settled.

 

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**ITEM 8. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

BPZ Resources, Inc.and SubsidiariesIndex to Consolidated Financial Statements

 
| Report of Independent  Registered Public Accounting Firm                                                                  | 54     |
|---------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                      |   |
| Consolidated  Balance Sheets as of December 31, 2008 and 2007                                                        | 55     |
|                                                                                                                      |   |
| Consolidated  Statements of Operations for the Years Ended December 31, 2008, 2007 and  2006                         | 56     |
|                                                                                                                      |   |
| Consolidated Statements of Stockholders’ Equity  (Deficit) for the Years Ended December 31, 2008, 2007 and 2006 | 57     |
|                                                                                                                      |   |
| Consolidated  Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and  2006                         | 58     |
|                                                                                                                      |   |
| Notes to Consolidated Financial Statements                                                                                | 59     |
|                                                                                                                      |   |
| Supplemental  Oil and Gas Disclosures (Unaudited)                                                                         | 88     |

 

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**Report of IndependentRegistered Public Accounting Firm**

 

To the Board of Directors BPZ Resources, Inc. and Subsidiaries

Houston, Texas

 

We have audited the accompanying consolidated balance sheets of BPZResources, Inc. and Subsidiaries as of December 31, 2008 and 2007,and the related consolidated statements of operations, stockholders’ equity(deficit), and cash flows for each of the three years in the period ended December 31,2008. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of BPZResources, Inc. and Subsidiaries at December 31, 2008 and 2007, andthe results of its operations and its cash flows for each of the three years inthe period ended December 31, 2008, in conformity with accountingprinciples generally accepted in the United States of America.

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), BPZ Resources, Inc.and Subsidiaries’ internal control over financial reporting as of December 31,2008, based on criteria established in Internal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO) and our report dated February 27, 2009, expressed anunqualified opinion thereon.

 

Johnson Miller & Co., CPA’s PC Midland, Texas

February 27, 2009

 

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**BPZResources, Inc. and SubsidiariesConsolidated Balance Sheets**

 
| ** **                                                                                                                                                                       | ** ** | **December 31,** | ** **  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|
| ** **                                                                                                                                                                       | ** ** | **2008**              | ** **  | **2007** | ** ** |
| ** **                                                                                                                                                                       | ** ** | ** **            | ** **  | ** ** | ** ** |
| **ASSETS**                                                                                                                                                                       |       |                  |        |   |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Current assets:                                                                                                                                                                  |       |                  |        |   |   |
| Cash and cash equivalents                                                                                                                                                        |       | $                     | 5,316,810   |   | $ | 7,514,188 |   |
| Restricted cash                                                                                                                                                                  |       | —                |        | 1,013,152 |   |
| Accounts receivable                                                                                                                                                              |       | 5,275,647             |        | 2,950,089 |   |
| Value added tax receivable                                                                                                                                                       |       | 12,109,605            |        | 7,496,547 |   |
| Inventory                                                                                                                                                                        |       | 4,053,536             |        | 3,372,883 |   |
| Prepaid and other current assets                                                                                                                                                 |       | 3,269,210             |        | 2,271,282 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Total current assets                                                                                                                                                             |       | 30,024,808            |        | 24,618,141 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Property, equipment and construction in  progress, net                                                                                                                           |       | 193,933,635           |        | 100,366,091 |   |
| Restricted cash                                                                                                                                                                  |       | 5,153,000             |        | 2,834,519 |   |
| Prepaid and other non-current assets                                                                                                                                             |       | —                |        | 230,433 |   |
| Investment in Ecuador property, net                                                                                                                                              |       | 1,382,436             |        | 1,570,020 |   |
| Deferred tax asset                                                                                                                                                               |       | 4,871,540             |        | — |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Total assets                                                                                                                                                                     |       | $                     | 235,365,419 |   | $ | 129,619,204 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                   |       |                  |        |   |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Current liabilities:                                                                                                                                                             |       |                  |        |   |   |
| Accounts payable                                                                                                                                                                 |       | $                     | 35,285,874  |   | $ | 11,774,316 |   |
| Accrued liabilities                                                                                                                                                              |       | 9,920,211             |        | 4,384,049 |   |
| Other liabilities                                                                                                                                                                |       | 719,663               |        | 263,439 |   |
| Current income taxes payable                                                                                                                                                     |       | 6,841,275             |        | — |   |
| Accrued interest payable                                                                                                                                                         |       | —                |        | 458,279 |   |
| Current maturity of long-term debt and  capital lease obligation                                                                                                                 |       | 7,819,908             |        | 6,188,668 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Total current liabilities                                                                                                                                                        |       | 60,586,931            |        | 23,068,751 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Asset retirement obligation                                                                                                                                                      |       | 580,786               |        | 273,048 |   |
| Long-term debt                                                                                                                                                                   |       | 15,017,511            |        | 15,537,293 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Total long-term liabilities                                                                                                                                                      |       | 15,598,297            |        | 15,810,341 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Commitments and contingencies (Note 15)                                                                                                                                          |       |                  |        |   |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Stockholders’ equity:                                                                                                                                                       |       |                  |        |   |   |
| Preferred stock, no par value, 25,000,000  authorized; none issued and outstanding                                                                                               |       | —                |        | — |   |
| Common stock, no par value, 250,000,000  authorized; 78,748,390 and 73,914,471 shares issued and outstanding at  December 31, 2008 and December 31, 2007, respectively |       | 227,136,599           |        | 149,050,032 |   |
| Accumulated deficit                                                                                                                                                              |       | (67,956,408           | )           | (58,309,920 | ) |
|                                                                                                                                                                             |       |                  |        |   |   |
| Total stockholders’ equity                                                                                                                                                  |       | 159,180,191           |        | 90,740,112 |   |
|                                                                                                                                                                             |       |                  |        |   |   |
| Total liabilities and stockholders’ equity                                                                                                                                  |       | $                     | 235,365,419 |   | $ | 129,619,204 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**BPZ Resources, Inc. and SubsidiariesConsolidated Statements of Operations**

 
| ** **                                                       | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                       | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                             |       |                                       |       |   |   |   |   |
| Revenue                                                          |       | $                                          | 62,954,901 |   | $ | 2,350,388 |   | $ | — |   |
|                                                             |       |                                       |       |   |   |   |   |
| Operating and administrative expenses:                           |       |                                       |       |   |   |   |   |
| Lease operating expense                                          |       | 11,648,877                                 |       | 754,833 |   | — |   |
| General and administrative                                       |       | 42,093,616                                 |       | 18,548,465 |   | 11,531,864 |   |
| Geological, geophysical and engineering                          |       | 794,925                                    |       | 4,045,381 |   | 2,048,742 |   |
| Depreciation, depletion and amortization                         |       | 16,061,540                                 |       | 792,531 |   | 213,815 |   |
|                                                             |       |                                       |       |   |   |   |   |
| Total operating expenses                                         |       | 70,598,958                                 |       | 24,141,210 |   | 13,794,421 |   |
|                                                             |       |                                       |       |   |   |   |   |
| Operating loss                                                   |       | (7,644,057                                 | )          | (21,790,822 | ) | (13,794,421 | ) |
|                                                             |       |                                       |       |   |   |   |   |
| Other income (expense):                                          |       |                                       |       |   |   |   |   |
| Income from investment in Ecuador property,  net of amortization |       | 717,571                                    |       | 264,031 |   | 1,403,298 |   |
| Interest expense                                                 |       | —                                     |       | — |   | (15,815 | ) |
| Registration delay expense                                       |       | —                                     |       | — |   | (3,552,513 | ) |
| Interest income                                                  |       | 319,424                                    |       | 854,905 |   | 787,455 |   |
| Other income/(expense)                                           |       | 102,425                                    |       | 200,904 |   | (315,463 | ) |
|                                                             |       |                                       |       |   |   |   |   |
| Total other income (expense)                                     |       | 1,139,420                                  |       | 1,319,840 |   | (1,693,038 | ) |
|                                                             |       |                                       |       |   |   |   |   |
| Loss before income taxes                                         |       | (6,504,637                                 | )          | (20,470,982 | ) | (15,487,459 | ) |
|                                                             |       |                                       |       |   |   |   |   |
| Income taxes                                                     |       | 3,141,851                                  |       | 39,001 |   | — |   |
|                                                             |       |                                       |       |   |   |   |   |
| Net loss                                                         |       | $                                          | (9,646,488 | ) | $ | (20,509,983 | ) | $ | (15,487,459 | ) |
|                                                             |       |                                       |       |   |   |   |   |
| Basic and diluted net loss per share                             |       | $                                          | (0.12      | ) | $ | (0.30 | ) | $ | (0.29 | ) |
|                                                             |       |                                       |       |   |   |   |   |
| Weighted average common shares outstanding                       |       | 77,389,536                                 |       | 69,156,404 |   | 53,751,761 |   |

 

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

 

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**BPZ Resources, Inc. and SubsidiariesConsolidated Statements of Stockholders’ Equity (Deficit)Years Ended December 31, 2008, 2007 and 2006**

 
| ** **                                                 | ** ** | **Common Stock** | ** ** | **Additional Paid-  in** | ** **  | **Stock  Subscription** | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|-------------------------------|-------------|-------------------------|------------|-----------------|------------|-------------|------------|
| ** **                                                 | ** ** | **Shares**            | ** ** | **Amount**                    | ** **  | **Capital**             | ** ** | **Receivable**  | ** ** | **Deficit** | ** ** | **Total** | ** ** |
| ** **                                                 | ** ** | ** **            | ** ** | ** **                    | ** **  | ** **              | ** ** | ** **      | ** ** | ** **  | ** ** | ** ** | ** ** |
| Balances at January 1, 2006                           |       | 40,349,979            |       | $                             | 56,873,641  |                    | $          | 2,401,239       |       | $           | (230,825   | ) | $ | (22,312,478 | ) | $ | 36,731,577 |   |
|                                                       |       |                  |       |                          |        |                    |       |            |       |        |       |   |   |
| Stock-based compensation                                   |       | 10,000                |       | 43,900                        |        | 318,281                 |       | —          |       | —      |       | 362,181 |   |
| Exercise of stock options assumed in acquisition           |       | 275,000               |       | 882,750                       |        | (882,750                | )          | —          |       | —      |       | — |   |
| Long-term incentive compensation plan, net of forfeitures  |       | (8,500                | )          | (143,599                      | )           | 3,006,926               |       | —          |       | —      |       | 2,863,327 |   |
| Common stock sold for cash, net of offering costs          |       | 12,652,000            |       | 36,835,500                    |        | —                  |       | —          |       | —      |       | 36,835,500 |   |
| Warrants issued in connection with sale of common stock    |       | —                |       | (248,645                      | )           | 248,645                 |       | —          |       | —      |       | — |   |
| Common stock issued for registration delay expenses        |       | 865,238               |       | 2,330,779                     |        | —                  |       | —          |       | —      |       | 2,330,779 |   |
| Net loss                                                   |       | —                |       | —                        |        | —                  |       | —          |       | (15,487,459 | )          | (15,487,459 | ) |
| Balances at December 31, 2006                         |       | 54,143,717            |       | 96,574,326                    |        | 5,092,341               |       | (230,825        | )          | (37,799,937 | )          | 63,635,905 |   |
|                                                       |       |                  |       |                          |        |                    |       |            |       |        |       |   |   |
| Stock-based compensation                                   |       | 5,000                 |       | 19,000                        |        | (24,891                 | )          | —          |       | —      |       | (5,891 | ) |
| Exercise of stock options assumed in merger                |       | 378,652               |       | 647,035                       |        | (647,035                | )          | —          |       | —      |       | — |   |
| Exercise of stock options                                  |       | 1,868,752             |       | 3,425,616                     |        | —                  |       | —          |       | —      |       | 3,425,616 |   |
| Long-term incentive compensation plan, net of forfeitures  |       | 1,348,350             |       | 12,020,140                    |        | (6,756,646              | )          | —          |       | —      |       | 5,263,494 |   |
| Incentive earn-out shares                                  |       | —                |       | —                        |        | 1,782,000               |       | —          |       | —      |       | 1,782,000 |   |
| Common stock sold for cash, net of offering costs          |       | 7,170,000             |       | 37,717,497                    |        | (799,351                | )          | 230,825         |       | —      |       | 37,148,971 |   |
| Common stock dividend (merger earn-out shares)             |       | 9,000,000             |       | —                        |        | —                  |       | —          |       | —      |       | — |   |
| Adjustment for negative APIC - deferred stock compensation |       | —                |       | (1,353,582                    | )           | 1,353,582               |       | —          |       | —      |       | — |   |
| Net loss                                                   |       | —                |       | —                        |        | —                  |       | —          |       | (20,509,983 | )          | (20,509,983 | ) |
| Balances at December 31, 2007                         |       | 73,914,471            |       | 149,050,032                   |        | —                  |       | —          |       | (58,309,920 | )          | 90,740,112 |   |
|                                                       |       |                  |       |                          |        |                    |       |            |       |        |       |   |   |
| Exercise of stock options assumed in merger                |       | 325,000               |       | 422,500                       |        | —                  |       | —          |       | —      |       | 422,500 |   |
| Exercise of stock options                                  |       | 567,100               |       | 2,046,342                     |        | —                  |       | —          |       | —      |       | 2,046,342 |   |
| Long-term incentive compensation plan, net of forfeitures  |       | —                |       | 18,463,765                    |        | —                  |       | —          |       | —      |       | 18,463,765 |   |
| Common stock sold for cash, net of offering costs          |       | 2,200,000             |       | 40,903,960                    |        | —                  |       | —          |       | —      |       | 40,903,960 |   |
| IFC debt conversion                                        |       | 1,491,819             |       | 15,500,000                    |        | —                  |       | —          |       | —      |       | 15,500,000 |   |
| Stock subscription agreement                               |       | 250,000               |       | 750,000                       |        | —                  |       | —          |       | —      |       | 750,000 |   |
| Net loss                                                   |       | —                |       | —                        |        | —                  |       | —          |       | (9,646,488  | )          | (9,646,488 | ) |
| Balances at December 31, 2008                         |       | 78,748,390            |       | $                             | 227,136,599 |                    | $          | —          |       | $           | —     |   | $ | (67,956,408 | ) | $ | 159,180,191 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**BPZ Resources, Inc. and SubsidiariesConsolidated Statements of Cash Flows**

** **
| ** **                                                                           | ** ** | **For the Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2008**                                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                 |       |                                                         |       |   |   |   |   |
| Cash flows from operating activities:                                                |       |                                                         |       |   |   |   |   |
| Net loss                                                                             |       | $                                                            | (9,646,488 | ) | $ | (20,509,983 | ) | $ | (15,487,459 | ) |
| Adjustments to reconcile net loss to net  cash used by operating activities:         |       |                                                         |       |   |   |   |   |
| Stock-based compensation                                                             |       | 18,463,765                                                   |       | 7,039,603 |   | 3,225,508 |   |
| Stock issued for registration delay  expenses                                        |       | —                                                       |       | — |   | 2,330,779 |   |
| Depreciation, depletion and amortization                                             |       | 16,061,540                                                   |       | 792,531 |   | 213,815 |   |
| Amortization of investment in Ecuador  property                                      |       | 187,584                                                      |       | 187,584 |   | 187,584 |   |
| Deferred income taxes                                                                |       | (4,871,540                                                   | )          | — |   | — |   |
| Net gain (loss) on the sale of asset                                                 |       | —                                                       |       | 9,207 |   | (150 | ) |
| Amortization of deferred financing fees                                              |       | —                                                       |       | 2,067 |   | — |   |
| Changes in operating assets and  liabilities:                                        |       |                                                         |       |   |   |   |   |
| Increase in accounts receivable                                                      |       | (2,325,558                                                   | )          | (2,950,089 | ) | — |   |
| Increase in value added tax receivable                                               |       | (4,613,058                                                   | )          | (4,336,849 | ) | (2,797,143 | ) |
| Increase in inventory                                                                |       | (661,434                                                     | )          | (1,200,269 | ) | (1,945,781 | ) |
| Decrease in other assets                                                             |       | 240,224                                                      |       | (298,783 | ) | (1,465,386 | ) |
| Increase in accounts payable                                                         |       | 23,511,558                                                   |       | 4,398,006 |   | 6,628,963 |   |
| Increase in accrued liabilities                                                      |       | 5,077,883                                                    |       | 1,534,673 |   | 2,378,744 |   |
| Increase in other income taxes payable                                               |       | 6,841,275                                                    |       | — |   | — |   |
| Increase in other liabilities                                                        |       | 456,224                                                      |       | 161,464 |   | 48,804 |   |
| Net cash provided by (used in) operating  activities                                 |       | 48,721,975                                                   |       | (15,170,838 | ) | (6,681,722 | ) |
|                                                                                 |       |                                                         |       |   |   |   |   |
| Cash flows from investing activities:                                                |       |                                                         |       |   |   |   |   |
| Property and equipment additions                                                     |       | (99,866,970                                                  | )          | (55,766,279 | ) | (34,575,535 | ) |
| Restricted cash                                                                      |       | (2,318,481                                                   | )          | (2,697,670 | ) | 305,953 |   |
| Net cash used in investing activities                                                |       | (102,185,451                                                 | )          | (58,463,949 | ) | (34,269,582 | ) |
|                                                                                 |       |                                                         |       |   |   |   |   |
| Cash flows from financing activities:                                                |       |                                                         |       |   |   |   |   |
| Borrowings                                                                           |       | 17,819,080                                                   |       | 15,500,000 |   | — |   |
| Repayments of borrowings                                                             |       | (10,450,784                                                  | )          | (17,345 | ) | (15,093 | ) |
| Deferred loan fees                                                                   |       | (225,000                                                     | )          | (232,500 | ) | — |   |
| Proceeds from exercise of warrants, net                                              |       | 750,000                                                      |       | — |   | — |   |
| Proceeds from exercise of stock options,  net                                        |       | 2,468,842                                                    |       | 3,425,616 |   | — |   |
| Proceeds from sale of common stock, net                                              |       | 40,903,960                                                   |       | 37,148,971 |   | 36,835,500 |   |
| Net cash provided by financing activities                                            |       | 51,266,098                                                   |       | 55,824,742 |   | 36,820,407 |   |
|                                                                                 |       |                                                         |       |   |   |   |   |
| Net decrease in cash and cash equivalents                                            |       | (2,197,378                                                   | )          | (17,810,045 | ) | (4,130,897 | ) |
| Cash and cash equivalents at beginning of  period                                    |       | 7,514,188                                                    |       | 25,324,233 |   | 29,455,130 |   |
| Cash and cash equivalents at end of period                                           |       | $                                                            | 5,316,810  |   | $ | 7,514,188 |   | $ | 25,324,233 |   |
|                                                                                 |       |                                                         |       |   |   |   |   |
| Supplemental cash flow information:                                                  |       |                                                         |       |   |   |   |   |
| **Cash paid for:**                                                                   |       |                                                         |       |   |   |   |   |
| Interest                                                                             |       | $                                                            | 4,678,454  |   | $ | 470,440 |   | $ | 15,815 |   |
| Income tax                                                                           |       | 1,165,210                                                    |       | 39,001 |   | — |   |
| **Non — cash items:**                                                           |       |                                                         |       |   |   |   |   |
| Purchase and additions to equipment with  the issuance of a capital lease obligation |       | $                                                            | 9,243,162  |   | $ | 6,170,146 |   | $ | — |   |
| Accrued interest capitalized to  construction in progress                            |       | 230,433                                                      |       | 458,279 |   | — |   |
| Depletion allocated to production inventory                                          |       | 19,219                                                       |       | 226,831 |   | — |   |
| Depreciation on support equipment  capitalized to construction in progress           |       | 976,967                                                      |       | 474,421 |   | 195,755 |   |
| Asset retirement obligation capitalized to  property and equipment                   |       | 268,574                                                      |       | 268,572 |   | — |   |

 

**The accompanying notes are an integral part of theseconsolidated financial statements.**

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

** **

**Note 1 — Basis ofPresentation and Significant Accounting Policies**

** **

**Organization**

** **

BPZ Resources, Inc., (the “Company” or “BPZ”)a Texas corporation, is based in Houston, Texas with offices in Lima, Peru andQuito, Ecuador. The Company is focused on the exploration, development andproduction of oil and natural gas in Peru and Ecuador. The Company also intendsto utilize part of its planned future natural gas production as a supply sourcefor the complementary development of a Company owned gas-fired power generationfacility.

 

The Company maintains a subsidiary registeredin Peru through our wholly-owned subsidiary BPZ Energy, Inc., a Texaslimited liability company, formerly BPZ Energy, Inc. (“BPZ — Texas”) andits subsidiary BPZ Energy International Holdings, L.P., a British VirginIslands limited partnership.. Currently, BPZ Energy has exclusive rights andlicense agreements for oil and gas exploration and production covering a totalof approximately 2.4 million acres, in four blocks, in northwest Peru. TheCompany’s license contracts cover 100% ownership of Block Z-1 (739,205 acres),Block XIX (472,860 acres), Block XXII (948,000 acres) and Block XXIII (248,000acres). The Block Z-1 contract was signed in November 2001, the Block XIXcontract was signed in December 2003 and Blocks XXII and XXIII contractswere signed in November 2007. The Company’s license contracts provide foran initial exploration period of seven and potentially up to thirteen years forBlock Z-1and seven and potentially up to ten years for Blocks XIX, XXII andXXIII. In addition, they require that the Company conduct specified activitieson the properties during this period. If the exploration activities aresuccessful, the total contract term can extend up to 30 years for oilexploration and production and up to 40 years for gas exploration andproduction. In the event a Block contains both oil and gas, as is the case inthe Company’s Block Z-1 contract, the 40 year term applies to oil explorationand production as well.

 

Through its wholly-owned subsidiary, SMCEcuador Inc., a Delaware corporation, and its registered branch in Ecuador, theCompany owns a 10% non-operated working interest in an oil and gas producingproperty, Block 2, located in the southwest region of Ecuador (the “Santa ElenaProperty”). The license agreement covering the property extends through May 2016.

 

The Company is in the initial stages ofdeveloping its oil and natural gas reserves and has begun producing oil andselling oil from the CX-11 platform in the Corvina field of Block Z-1 under anextended well testing program. Additionally, the Company’s activities in Peruinclude analysis and evaluation of technical data on its properties,preparation of the development plans for the properties, including detailedengineering and design of the power plant and gas processing facilities,refurbishment of and designs for platforms to be used under an extended welltesting program, procuring machinery and equipment for an extended drillingcampaign, obtaining all necessary environmental and operating permits, bringingadditional production on-line and securing the required capital and financingto conduct the current plan of operation.

 

***Corvina Field***

 

TheCompany is producing oil from its recent discoveries at the CX-11 platform,located in the Corvina Field within the offshore Block Z-1, under an extendedwell testing program which began on November 1, 2007.  The Corvinafield consists of 47,000 acres in water depths of less than 200 feet.  TheCompany is currently concentrating its drilling efforts on West Corvina, whichconsists of 3,500 acres and have completed a total of four oil producing wells,the CX11-21XD, CX11-20XD, the CX11-18XD and the CX11-14D.  The oil isdelivered by barge to the Petroleos del Perú-PETROPERU S.A. (“Petroperu”)refinery in Talara, located approximately 70 miles south of the platform. Produced oil is kept in production inventory until such time it is delivered tothe refinery.

 

OnOctober 24, 2007, Tecnomarine, the Company’s former primary marinetransportation contractor, entered into two short-term agreements with thecommercial division of the Peruvian Navy to lease two small tankers to for usein its offshore oil production operation.  On January 30, 2008, oneof the tankers, the T/V SUPE (“Supe”), sank after catching fire.  At thetime of the incident, the tanker contained approximately 1,300 barrels of oil,most of which burned in the fire. Official environmental impact assessmentsconcluded that environmental issues have been adequately controlled. On December 18,2008, a lawsuit was filed by two crewmembers and the family and estate of twoof the deceased crewmembers of the Supe against the Company. As none of thePeruvian government sanctioned investigations into the Supe incident foundfault on the part of Tecnomarine, the Company or the Company’s subsidiary, BPZExploración & Producción S.R.L., the Company does not currentlybelieve based upon the known facts relating to the incident that the claimsasserted against BPZ are 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

meritorious and intends to vigorouslydefend itself. The Company believes the incident would be covered by itsinsurance policies, after a customary deductible. As a result of theincident, operations were voluntarily suspended at the CX-11 platform. Forfurther information regarding the civil claims asserted against us seeNote 15, “Commitment and Contingencies” and Note-16, “Legal Proceedings”.

 

OnMarch 14, 2008, The Company was notified by the Organismo Supervisor de laInversión en Energía y Mineria (“OSINERGMIN”)  the government regulatoryagency in Peru responsible for monitoring industrial safety, that it couldresume drilling and testing operations at the CX-11 platform allowing theCompany to begin testing the CX11-18XD well.  Three drill stem tests wereconducted in the Upper Zorritos formation.  The first two drill stem teststargeted the lower sands in zones that had not previously been tested. The third drill stem test targeted sands that had tested oil in the Company’sCX11-21XD well.  The Company began producing from the CX11-18XD well in May 2008and, on June 9, 2008; it received the clearance needed to transport oilfrom the CX-11 platform to the nearby Talara refinery by the correspondingPeruvian environmental agency.  In addition, the Company’s floatingproduction storage and offloading (“FPSO”) vessel was placed into service inthe Corvina field and is currently being used in the extended well testingprogram to process produced crude oil.

 

Uponcompletion of the CX11-18XD well, the Company began drilling operations on theCX11-20XD well in May 2008.  The CX11-20XD well is positioned higherup in the geologic structure from the CX11-21XD well.  The well has beenpositioned to further develop the top gas sands found in the previously drilledCX11-21XD well, the oil sands currently producing in the CX11-21XD andCX11-18XD wells, the oil sands encountered and briefly tested in the CX11-18XDwell during the initial drill-stem test number one, as well as sands found inthe CX11-14D well.  The well tested positive for oil in quantities thatthe Company believes to be commercially producible.  The Company hascompleted two drill stem tests on four sets of oil sands in the well.  On November 1,2008, the Company completed the CX11-20XD well as an oil-producing well underan extended well testing program currently ongoing at the Corvina field.However, because the well crosses sands which tested positive for what itbelieve to be economic quantities of gas, during the drilling and testing ofboth the CX11-21XD and CX11-18XD wells, it intends to re-complete the CX11-20XDwell, with dual production strings, when gas is needed for the gas-to-powerproject, to allow the well to produce gas as well as oil.

 

OnNovember 21, 2008, the Company began drilling operations on the CX11-15Dwell in the Corvina field located within the offshore Block Z-1 in northwestPeru. The CX11-15Dtargeted the known oil and gas sands higher in the geological formation withthe main objective of proving up a portion of the probable oil and gas reservesand giving the Company another oil producing well. During the testing it wasconfirmed that the deeper prospective sands were found lower than expected andwere located below the estimated oil-water contact, thus testing formationwater. The tests in the upper oil zones resulted in no flow due to the qualityof the sands in this location. However, the gas sands in the gas zone wereencountered higher than expected, which should allow the Company to prove upsome of the probable gas reserves. Operations have commenced to sidetrack theCX11-15D well, targeting a location higher in the geological formation. Oncethe sidetrack is complete, in approximately one month, the Company will testthe prospective oil sands which, in this location, should be above the oil-watercontact and of better quality. As part of the extended well testing program,the well will then be placed on production if commercial amounts of oil aretested. The Company anticipates production increases in the field based on theCX11-15D well being completed in late March.

 

As of December 31, 2008, the Company has fouroil producing wells, the CX11-21XD, CX11-20XD, the CX11-18XD and the CX11-14Dunder an extended well testing program. For 2009 the Company intends to keepthe drilling rig currently at the CX-11 platform to focus on oil development inthe offshore Block Z-1 and to drill three additional oil development wells tomaximize cash flow.

 

***Albacora Field***

 

TheAlbacora Field is located in the northern part of the offshore Block Z-1. Based on the Company’s internally developed models, the Albacora field consistof approximately 6,000 acres and, like the Corvina field, is located in waterdepths of less than 200 feet. In 2009, once the contracted drilling rig (thePTX18) has been mobilized to the Albacora A-1 platform, which is currentlybeing refurbished, the Company plans to drill the A-14XD well, a twin well toAlbacora’s 8-X-2 discovery well. The PTX18 rig is contracted with Petrex, theCompany’s current drilling contractor, for a period of three years. This rigwill be capable of drilling to approximately 14,000 feet, and will be modifiedto drill from an offshore platform. This first well in Albacora will qualify asan exploratory well as the Company plans on testing the prospective 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

Lower Zorritos formationsands.  The 8-X-2 discovery well, drilled 35 years ago, tested oil and gasin the upper Zorritos formation sands at quantities the Company believes to becommercially producible.  The Company’s drilling plans in Albacora are to drilltwo new wells in 2009.

 

***Gas-to-Power Project***

 

TheCorvina gas-to-power project entails the installation of a 10-mile gas pipelinefrom the CX-11 platform to shore, construction of gas processing facilities andan approximately 135 megawatt (“MW”) simple-cycle electric generatingplant.  The proposed power plant site is located adjacent to an existingsubstation and power transmission lines which, with certain upgrades, areexpected to be capable of handling up to 360 MW of power. In order to support theCompany’s proposed electric generation project, it commissioned an independentpower market analysis for the region. The Peruvian electricity market isderegulated and power is transported through an interconnected national gridmanaged by the Committee for Economic Dispatching of Electricity (known as “COES”).Based on this study, the Company believes it will be able to sell economicquantities of electricity from the initial 135 MW power plant. The market studyalso indicates that there may be future opportunities for the Company togenerate and sell significantly greater volumes of power into the Peruvian andpossibly Ecuadorian power markets.  Accordingly, the revenues from thenatural gas delivered to the power plant will be derived from the sale of electricity.As a result of factors outside the Company’s control, as further discussedbelow, it has postponed development of the gas-to power project until such timeas the necessary financing, personnel and equipment becomes available tocontinue the project, including finding a joint venture partner to assist inthe gas-to-power project.

 

*GE Turbine Purchase Agreement*

 

On September 26, 2008, the Company through itspower generation subsidiary, Empresa Eléctrica Nueva Esperanza, SRL, enteredinto a $51.5 million contract for purchase of equipment and services (the “Agreement”)with GE Packaged Power, Inc. and GE International, Inc. Sucursal dePeru (collectively “GE”), which are part of GE Energy’s aeroderivativebusiness.  The Agreement obligates the Company to purchase three LM6000gas-fired turbines. Each turbine will have a generation capacity of 45megawatts, with excess capacity of approximately 5%.  Delivery of thethree units was initially scheduled for the fourth quarter 2009.

 

In January 2009, as a result of the Company’sdecision to focus on increasing oil production, cash flow and reserves from theCorvina and Albacora fields during 2009, BPZ and GE entered into an amendmentof the Agreement. Under the terms of the amendment, both GE and BPZ, agree to asuspension period under the Agreement from and including December 15, 2008through November 15, 2009, whereby no failure on the part of BPZ or GE toperform any obligations under the Agreement will give rise to a breach ofcontract or give right to terminate the contract, provided that the Companymakes a payment to GE in the amount of $3.4 million no later than February 25,2009. As of February 24, 2009, we paid $3.4 million related to milestonepayment four to GE. In addition the Company agrees to make a payment in theamount of $3.5 million to GE no later than November 16, 2009. Any failureto make these payments in full will result in immediate termination of theAgreement with no cure period or time to correct the breach.

 

Once the Company decides to bring the Agreement outof the suspension period, it will provide evidence that payment security hasbeen established and new delivery dates, pricing and payment terms will bedetermined by the BPZ and GE. All previous payments made by the Company on theAgreement will be applied to the new price.

 

**Reincorporation,Name Change and Internal Restructuring**

** **

On October 11, 2007, BPZ Energy, Inc.,a Colorado corporation, formerly named Navidec, Inc., (“Navidec”),completed a reincorporation from the State of Colorado to the State of Texaspursuant to the Plan of Conversion as approved by the shareholders at the 2007annual meeting of shareholders held on August 17, 2007. The relatedfilings with the Secretary of State of Texas also included a change of thecompany’s name from BPZ Energy, Inc. to BPZ Resources, Inc., inconnection with an ongoing review of certain internal reorganization mattersrelated to our international tax planning and corporate structure. The Companycontinues to do business under the name BPZ Energy in its regular businessoperations.

 

No changes to the members of the Board ofDirectors, the management, or the operations of the Company were made inconnection with the reincorporation from a Colorado corporation to a Texascorporation. The Company remains the same business entity following thereincorporation to Texas, with all of the assets, rights, privileges and powersof, and all 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

property owned by, all debtsdue to, as well as any other causes of action belonging to the predecessorColorado entity. As part of the reincorporation, a new Certificate of Formationand new Bylaws were adopted, and now govern the rights of holders of theCompany’s common stock. At the effective time of the reincorporation, eachoutstanding share of the Colorado entity prior to the reincorporation wasautomatically converted into one share of the Texas entity.

 

**Basis of Presentation and****Principles of Consolidation**

 

The consolidatedfinancial statements include the accounts of the Company and its wholly-ownedsubsidiaries and branch offices. All intercompany balances and transactionshave been eliminated.

 

The Company’s accountingpolicy regarding partnership or joint venture interests in oil and gasproperties is to consolidate such interests on a pro-rata basis in accordancewith accepted practice in the oil and gas industry. However, the Company hasnot been able to receive timely information to allow it to proportionatelyconsolidate the minority non-operated working interest owned by its consolidatedsubsidiary, SMC Ecuador Inc. See Note 6 “Investment in Ecuador Property” 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.

 

**Revenue Recognition**

 

The Company does not recognize revenues until theyare realized or realizable and earned. Revenues are considered realized orrealizable and earned when: (i) persuasive evidence of an arrangementexists, (ii) delivery has occurred or services have been rendered, (iii) theseller’s price to the buyer is fixed or determinable and (iv) collectabilityis reasonably assured.

 

The Company sells its production in thePeruvian domestic market on a contract basis. Revenue is recorded net ofroyalties when the purchaser takes delivery of the oil. At the end of theperiod, oil that has been produced but not sold is recorded as inventory at thelower of cost or market. Cost is determined on a weighted average based onproduction costs.

 

**Reporting andFunctional 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, NuevoSol, 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, a translationgain of approximately $0.1 million, $0.2 million and $0.1 million was recognized during the year ended December 31,2008, 2007 and 2006, respectively. The primary reason for thetranslation difference related to the early recovery of Value Added Tax in Peru(“IGV”), which by Peruvian law must be transacted and accounted for in thelocal currency. However, the total gainduring 2008 was partially offset by Nuevo Sol denominated accounts payablebeing settled.

 

**Use of Estimates**

** **

The preparation of theconsolidated financial statements in accordance with U.S. generally acceptedaccounting principles requires management to make certain estimates andassumptions. These estimates and assumptions affect the reported amounts ofassets, liabilities, revenues and expenses in the consolidated financialstatements, and the disclosure of contingent assets and liabilities. Actualresults could differ from these estimates.

 

**Cash and CashEquivalents**

** **

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 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

are maintained in foreign bankswhich are not covered by deposit insurance. The cash balance in the Company’sU.S. bank accounts may exceed federally insured limits.

 

**Restricted Cash**

** **

As discussed in Note 7, “RestrictedCash” contained herein under notes to the consolidated financial statements,the Company has secured various performance bonds, collateralized primarily bycertificates of deposit, to guarantee its obligations and commitments inconnection with its exploratory properties in Peru. All of the performancebonds have been issued by Peruvian banks and their terms are dictated by thecorresponding License Contract or Agreement.

 

****Allowance for Doubtful Accounts****

 

Currently, the Company’s contract termsregarding oil sales have a relatively short settlement period. However, theCompany regularly reviews all aged accounts receivables for collectability andestablishes an allowance as necessary for balances greater than 90 daysoutstanding. Currently all receivables are current or were outstanding lessthan thirty days. It is the Company’s belief that there are no balances inaccounts receivable that will not be collected and that an allowance was notnecessary at December 31, 2008 and December 31, 2007, respectively.

 

**Property,Equipment and Construction in Progress**

** **

The Company follows the “successfulefforts” method of accounting of its costs of acquisition, exploration anddevelopment of 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 well. All costs related tounsuccessful exploratory wells are expensed when such wells are determined tobe non-productive or at the one year anniversary of completion of the well ifproved reserves have not been attributed and capital expenditures as describedin the preceding sentence are not required.

 

The Company assesses itscapitalized exploratory wells pending evaluation each quarter to determinewhether costs should remain capitalized or should be charged to earnings. Otherexploration costs, including geological, geophysical and engineering costs, areexpensed as incurred. The Company recognizes gains or losses on the sale ofproperties, should they occur, on a field-by-field basis.

 

Projects underconstruction are not depreciated or amortized until placed in service. Forassets we construct, we capitalize direct costs, such as labor and materials,and indirect costs, such as overhead and interest. As of December 31,2008, property and equipment consists of office equipment, vehicles andleasehold improvements made to the Company’s offices. All such values arestated at cost and are depreciated on a straight-line basis over the estimateduseful life of the assets which is ranges between three and five years, or theterm of the lease. Barges and related equipment are depreciated on astraight-line basis over the estimated useful life of the asset which isbetween fifteen and twenty years. Maintenance and repairs are expensed asincurred. Replacements, upgrades or expenditures which improve and extend thelife of the assets are capitalized. When assets are sold, retired or otherwisedisposed, the applicable costs and accumulated depreciation and amortizationare removed from the appropriate accounts and the resulting gain or loss isrecorded.

 

**Impairment ofLong-Lived Assets**

** **

The Company periodicallyevaluates the recoverability of the carrying value of its long-lived assets,goodwill and identifiable intangibles by monitoring and evaluating changes incircumstances that may indicate that the carrying amount of the asset may notbe recoverable. Examples of events or changes in circumstances that indicatethat the recoverability of the carrying amount of an asset should be assessedinclude but are not limited to the following: a significant decrease in themarket value of an asset, a significant change in the extent or manner in whichan asset is used or a significant physical change in an asset, a significantadverse change in legal factors or in the business climate that could affectthe value of an asset or an adverse action or assessment by a regulator, anaccumulation of costs significantly in excess of the amount 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

originally expected to acquireor construct an asset, and/or a current period operating or cash flow losscombined with a history of operating or cash flow losses or a projection orforecast that demonstrates continuing losses associated with an asset used forthe purpose of producing revenue.

 

The Company considers historical performanceand anticipated future results in its evaluation of potential impairment.Accordingly, when indicators of impairment are present, the Company evaluatesthe carrying value of these assets in relation to the operating performance of thebusiness and future discounted and non-discounted cash flows expected to resultfrom the use of these assets. Impairment losses are recognized when theexpected future cash flows from an asset are less than its carrying value. Forthe years ended December 31, 2008, 2007 and 2006, there was no impairmentlosses recognized by the Company.

 

**StockBased Compensation**

** **

On January 1, 2006, the Company adopted SFAS No. 123— Revised 2004,*“*Share—Based Payment” (“SFAS No. 123(R)”),which establishes accounting for stock-based payment transactions for employeeservices and goods and services received from non-employees. SFAS No. 123(R) isa revision of SFAS No. 123, “Accounting for Stock-Based Compensation”, andsupersedes APB No. 25, “Accounting for Stock Issued to Employees”. Underthe provisions of SFAS No. 123(R), stock-based compensation cost ismeasured at the date of grant, based on the calculated fair value of the award,and is recognized as expense in the Consolidated Statements of Operationsratably over the employee’s or non-employee’s requisite service period, whichis generally the vesting period of the equity grant. Additionally, stock-basedcompensation cost is recognized based on awards that are ultimately expected tovest, therefore, the compensation cost recognized on stock-based paymenttransactions is reduced for estimated forfeitures based on the Company’shistorical forfeiture rates.

 

The Company adopted SFAS No. 123(R) using the modifiedprospective application method and, accordingly, no prior periods have beenrestated as a result of the adoption of this pronouncement. The modified prospective method requiresrecognition of compensation expense for stock-based payment awards that aregranted, modified, repurchased or cancelled after 2005. Compensation expensefor unvested stock options outstanding as of January 1, 2006 for which therequisite service has not been rendered is being recognized over the remainingservice period using the compensation cost previously calculated for pro formadisclosure purposes under SFAS No. 123. See Note 10, “Stockholders’Equity” for further discussion of the Company’s stock-based compensation plans.

 

**CapitalizedInterest**

 

Certain interest costshave been capitalized as part of the cost of oil and gas properties underdevelopment, including wells in progress and related facilities. Total interestcosts capitalized during the year ended December 31, 2008 and 2007 was$4.2 million and $0.9 million, respectively. No interest was capitalized duringthe year ended December 31, 2006 due to the lack of operational debtduring that period.

 

**Fair Value ofFinancial Instruments**

** **

The Company’s financialinstruments consist primarily of cash, trade receivables, trade payables anddebt. The book values of cash, trade receivables and trade payables areconsidered to be representative of their respective fair values due to theshort-term maturity of those instruments. The fair value of debt at December 31,2008 and 2007 approximates the carrying value because the interest rates arebased on floating rates identified by reference to market rates and because theinterest rates charged are at rates at which the Company can currently borrow.

 

**Income Taxes**

** **

The Company accounts forincome taxes in accordance with SFAS 109, “Accounting for Income Taxes” (“SFAS109”). Under SFAS 109, deferred tax assets and liabilities are determined basedon differences between the financial reporting and tax basis of assets andliabilities, and are measured using the enacted tax rates and laws that will bein effect when the differences are expected to reverse. Valuation allowancesare established when necessary to reduce deferred tax assets to the amountexpected to be realized.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Environmental**

** **

The Company is subject toenvironmental laws and regulations of various U.S. and internationaljurisdictions. These laws and regulations, which are subject to change,regulate the discharge of materials into the environment and may require theCompany to remove or mitigate the environmental effects of the disposal orrelease of petroleum or chemical substances at various sites.

 

Environmental costs thatrelate to current operations are expensed or capitalized as appropriate. Costsare expensed when they relate to an existing condition caused by past operationsand will not contribute to current or future revenue generation. Liabilitiesrelated to environmental assessments and/or remedial efforts are accrued whenproperty or services are provided and when such costs can be reasonablyestimated. The Company’s cost for these studies and assistance related to theBlock Z-1 Corvina and Albacora fields and Block XIX for the year ended December 31,2008, 2007 and 2006 were approximately $0.5 million, $0.3 million and $0.5million, respectively.

 

**Loss per CommonShare**

** **

In accordance withprovisions of SFAS No. 128, “Earnings per Share”, basic earnings per shareis computed on the basis of the weighted-average number of common sharesoutstanding during the periods. Diluted earnings per share is computed basedupon the weighted-average number of common shares outstanding plus the assumedissuance of common shares for all potentially dilutive securities. Dilutedearnings per share equals basic earnings per share for the periods presentedbecause the effects of potentially dilutive securities are antidilutive.

 

**Recent Accounting Pronouncements**

 

***SEC Amendments to Oil and Gas ReportingRequirements***

 

OnDecember 31, 2008 the Securities and Exchange Commission (“SEC”) adoptedthe final rules regarding amendments to current oil and gas reportingrequirements. The amendments are designed to modernize and update the oil andgas disclosure requirements to align them with current practices and changes intechnology and include the following:

 

·                  Requiring companies to report oiland gas reserves using an average price based upon the prior 12-monthperiod-rather than year-end prices.

·                  Enabling companies to additionallydisclose their probable and possible reserves.

·                  Requiring previously nontraditionalresources, such as oil shales, to be classified as oil and gas reserves if thenontraditional resources are intended to be upgraded to synthetic oil and gas.

·                  Requiring companies to report theindependence and qualifications of a preparer or auditor, based on currentSociety of Petroleum Engineers criteria.

·                  Requiring the filing of reports forcompanies that rely on a third party to prepare reserves estimates or conduct areserves audit.

·                  Permitting the use of newtechnologies to determine proved reserves if those technologies have beendemonstrated empirically to lead to reliable conclusions about reservesvolumes.

 

Theamendments are effective for registration statements filed on or after January 1,2010, and for annual reports on Forms 10-K and for fiscal years ending on orafter December 31, 2009. Early adoption is not permitted in either annualor quarterly reports before the first annual report in which the reviseddisclosures are required. The Company is currently evaluating the impact of theamendments on its consolidated financial position, results of operations andcash flows.

 

***Business Combinations***

 

InDecember 2007, the Financial Accounting Standards Board (“FASB”) issuedSFAS No. 141 (revised 2007), “BusinessCombinations” (“SFAS No. 141(R)”), which replaces FASB Statement No. 141.SFAS No. 141(R) establishes principles and requirements for how anacquirer recognizes and measures in its financial statements the identifiableassets acquired, the liabilities assumed, any non- controlling interest in theacquiree and the goodwill acquired.  SFAS No. 141(R) alsoestablishes disclosure requirements that will enable users to evaluate thenature and financial effects of the 

 

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**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

business combination. SFAS No. 141(R) is effective for acquisitions that occur in an entity’sfiscal year that begins after December 15, 2008, which will be the Company’sfiscal year 2009.  The Company adopted the provisions of SFAS No. 141(R) onJanuary 1, 2009 and the adoption did not have a material impact on itsfinancial statements.

 

***Share Based Payments***

 

OnDecember 21, 2007, the SEC released Staff Accounting Bulletin, (“SAB 110”)“Share-Based Payment” which will no longer allow the use of the “simplified”method to estimate the expected terms as on the variables to determine the fairvalue of share-based payments.  With a limited number of exceptions,companies can continue to use the simplified method.  However, doing sorequires the types of grants for which the simplified method is used if not forall grants, and the periods for which the simplified method is beingused.  The adoption of this Staff Accounting Bulletin had no materialimpact on our consolidated financial position, results of operations, or cashflows.

 

****Fair Value Measurements****

 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurement” (“SFASNo. 157”).  SFAS No. 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements.  SFAS No. 157is effective for financial statements issued for periods beginning after November 15,2007.  SFAS No. 157 applies under other accounting pronouncementsthat require or permit fair value measurements, the FASB having previouslyconcluded in those accounting pronouncements that fair value is the relevantmeasurement attribute.  Accordingly, SFAS No. 157 does not requireany new fair value measurements.  However, for some entities, theapplication of this SFAS No. 157 will change current practice.  Thedefinition of fair value focuses on the price that would be received to sellthe asset or paid to transfer the liability (an exit price), not the price thatwould be paid to acquire the asset or received to assume the liability (an entryprice).  SFAS No. 157 emphasizes that fair value is a market-basedmeasurement, not an entity-specific measurement.  In February 2008,the FASB issued FASB Staff Position (“FSP”) SFAS 157-2 (“SFAS 157-2”) whichdefers the effective date of SFAS No. 157 for non-financial assets andliabilities that are not recorded at fair value on a recurring basis untilperiods beginning after November 15, 2008.  The Company adopted SFAS No. 157effective January 1, 2008, except for those provisions permitted to bedelayed by SFAS 157-2.  Accordingly, the Company has not applied theprovisions of SFAS No. 157 to non-financial assets and liabilitiesinitially measured at fair value.  In general, fair value measurements anddisclosures are made in accordance with the provisions of SFAS No. 157. The adoption of SFAS No. 157 had no impact on its consolidated financialposition, results of operations or cash flows. The Company adopted theprovisions of SFAS 157-2 on January 1, 2009 and the adoption did not havea material impact on its financial statements consolidated financial position,results of operations or cash flows.

 

***TheFair Value Option for Financial Assets and Financial Liabilities***

 

InFebruary 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—Including an Amendment of FASB Statement No. 115” (“SFASNo. 159”).  This standard permits an entity to choose to measure manyfinancial instruments and certain other items at fair value.  Most of theprovisions in SFAS No. 159 are elective; however, the amendment to FASBStatement No. 115, Accounting for Certain Investments in Debt and EquitySecurities, applies to all entities with available-for-sale and tradingsecurities.  SFAS No. 159 is effective for fiscal years beginning afterNovember 15, 2007.  On January 1, 2008, the Company adopted SFASNo. 159 and elected not to measure any of its currently eligible assetsand liabilities at fair value.

 

***Hierarchyof Generally Accepted Accounting Principles***

 

InMay 2008, the FASB issued SFAS No. 162, “The Hierarchy of GenerallyAccepted Accounting Principles,” which identifies the sources of accountingprinciples and the framework for selecting the principles used in thepreparation of financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles(GAAP) in the United States of America. This statement is effective60 days following the SEC’s approval of the Public Company AccountingOversight Board amendments to AU Section 411, “The Meaning of PresentFairly in Conformity with Generally Accepted Accounting Principles.” TheCompany does not expect the adoption of SFAS No. 162 to have a materialimpact on its consolidated financial position, results of operations or cashflows.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

***ParticipatingSecurities***

 

In June 2008, the FASB issued FSP EITF 03-6-1 “DeterminingWhether Instruments Granted in Share-Based Payment Transactions AreParticipating Securities,” (“FSP EITF 03-6-1”) which provides that unvestedshare-based payment awards that contain nonforfeitable rights to dividends ordividend equivalents (whether paid or unpaid) are participating securities and,therefore, need to be included in the earnings allocation in computing earningsper share under the two class method. FSP EITF 03-6-1 is effective for us on January 1,2009 and all prior-period EPS data (including any amounts related to interimperiods, summaries of earnings and selected financial data) will be adjustedretroactively to conform to its provisions. Early application of FSP EITF03-6-1 is not permitted. The Company adopted the provisions of FSP EITF 03-6-1on January 1, 2009 and the adoption, although restricted stock awards meetthis definition, did not have a significant material impact on its reportedearnings per share.

 

**Note 2 — Value Added Tax Receivable**

 

Value-added tax (referred to as “IGV” in Peru) is generally imposed ongoods and services at a rate of 19%. Peru currently has an IGV early recoveryprogram for companies during the exploration phase. Under this program, IGVpaid on the acquisition of certain goods and services used directly inhydrocarbon exploration activities can be recovered prior to a commercialdiscovery taking place or production and revenue billings begin. Because the Companyhas oil sales, it is no longer eligible for the IGV early recovery program.

 

The Company’s value added tax receivablebalance as of December 31, 2008 was $12.1 million. In 2008, the Companyreceived approximately $3.8 million under the IGV early recovery program forclaims previously filed with the Peruvian tax authority in 2007. During theyear ended, December 31, 2008 the Company accrued approximately $19.6million for IGV related to expenditures during the year and offset IGV byapproximately $11.2 million related to the sale of oil in 2008.

 

The Company’s value added tax receivablebalance as of December 31, 2007 was $7.5 million. Of this balance, theCompany has filed claims with the Peruvian tax authority to recoverapproximately $2.9 million under the IGV early recovery program. During theyear ended, December 31, 2007 the Company accrued approximately $11.4million for IGV related to expenditures during the year and offset IGV byapproximately $0.5 million related to the sale of oil in December 2007.Approximately $6.6 million of IGV was collected during the year ended December 31,2007.

 

**Note 3 — Inventory**

 

Inventories consist primarily of crude oil,tubular goods, accessories and spare parts for production equipment, stated atthe lower of average cost or market. The balance of inventory at December 31,2008 and 2007 was $4.1 million and $3.4 million, respectively. Inventoryassociated with tubular goods, accessories and spare parts inventory at December 31,2008 and 2007 was $3.6 million and $2.8 million, respectfully.

 

The Company also maintainscrude oil inventories in storage barges. These inventories are also stated atthe lower of average cost or market value. Cost is determined on a weightedaverage basis based on production costs. The product inventory at December 31,2008 consisted of approximately 11,656 barrels of crude oil at an estimatedcost of $437,765 or $37.56 per barrel. The product inventory at December 31,2007 consisted of approximately 12,248 barrels of crude oil at an estimatedcost of $548,391 or $44.77 per barrel.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Note 4 — Prepaidand Other Current Assets**

 

Below is a summary ofother current assets as of December 31, 2008 and 2007:

 
| ** **                 | ** ** | **2008** | ** ** | **2007**  | ** ** |
|----------------------------|------------|----------|------------|-----------|------------|
|                       |       |     |       |      |       |
| Prepaid expenses and other |       | $        | 1,980,599  |      | $          | 590,784 |   |
| Deposits                   |       | 86,390   |       | 51,964    |       |
| Prepaid insurance          |       | 590,189  |       | 1,015,676 |       |
| Insurance receivable       |       | 612,032  |       | 612,033   |       |
| Interest receivable        |       | —   |       | 825       |       |
|                       |       |     |       |      |       |
|                       |       | $        | 3,269,210  |      | $          | 2,271,282 |   |

 

Prepaid expenses and other are primarilyrelated to prepayments for drilling services, equipment rental and materialprocurement. Depositsare primarily rent deposits in connection with the Company’s offices in Houstonand Peru. Prepaid insurance consists of premiums related to the Company’soperations as well as general liability and directors and officer’s insurancepolicies. Insurance receivable is related to the barge incident which occurredin early August 2006. The Company incurred an operational delay ofapproximately three weeks resulting from a navigation incident which caused theBPZ-01 barge to be grounded on a sand bank in Talara Bay in northwest Peru duringthe second mobilization trip to the Corvina platform. As of December 31,2008, a claim of approximately $0.8 million for repairs is expected to be filedwith the insurance carrier. Adeductible of $75,000 will be applied to this insurance claim when reimbursed. The Company received proceeds from the underwriter to cover a relatedclaim regarding third party cargo that was damaged in the grounding incident.During the year ended December 31, 2008, approximately $80,000 ofinsurance proceeds was received in connection with this claim.  Adeductible of $25,000 was offset against the insurance proceeds received. This amount is unrelated to the $0.8 million hull claim described above as theproceeds from the cargo claim were passed on to the third party owner of thecargo that was damaged.  The hull claim will be finalized upon the drydocking of the vessel.  Because of the delays caused by the drilling ofthe highly deviated CX11-20XD well during the third quarter 2008, the dry dockof the BPZ-01 is scheduled during the last quarter of 2009.

 

**Note 5 — Property,Equipment and Construction in Progress**

 

Below is a summary ofproperty, equipment and construction in progress as of December 31, 2008and 2007:

 
| ** **                                              | ** ** | **2008**    | ** **  | **2007**   | ** ** |
|---------------------------------------------------------|------------|-------------|-------------|------------|------------|
|                                                    |       |        |        |       |       |
| Construction in progress:                               |       |        |        |       |       |
| Power plant and related equipment                       |       | $           | 17,483,626  |       | $          | 3,486,309 |   |
| Platforms and wells                                     |       | 34,768,367  |        | 25,220,425 |       |
| Pipelines and processing facilities                     |       | 5,108,387   |        | 4,412,677  |       |
| Producing properties                                    |       | 110,229,530 |        | 56,159,488 |       |
| Producing equipment                                     |       | 18,399,383  |        | —     |       |
| Barge and related equipment                             |       | 24,926,842  |        | 11,970,171 |       |
| Office equipment, leasehold improvements,  and vehicles |       | 1,959,656   |        | 1,040,613  |       |
| Accumulated depreciation and amortization               |       | (18,942,156 | )           | (1,923,592 | )          |
|                                                    |       |        |        |       |       |
| Net property, equipment and construction in  process    |       | $           | 193,933,635 |       | $          | 100,366,091 |   |

** **

Duringthe year ended December 31, 2008 and 2007, the Company incurred capitalexpenditures of approximately $110.6 million and $63.1 million,respectively, associated with our development initiatives for the explorationand production of oil and natural gas reserves and the complementarydevelopment of proprietary gas-fired power generation of electricity for salein Peru.

 

Ofthe incurred costs mentioned above, the Company incurred capital expendituresrelated to the drilling and testing of the CX11-18XD, the CX11-20XD, CX11-15Dwells of approximately $19.0 million, $31.2 million, and $11.2 million,respectively, during the year ended December 31, 2008.  For theyear ended December 31, 2007 the Company incurred 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARS ENDEDDECEMBER 31, 2008, 2007 and 2006**

 

capital expenditures related tothe drilling and testing of the CX11-21XD and the CX11-14D wells of $29.4million and $22.8 million, respectively. Approximately $52.3 million and $55.9million and was transferred from construction in progress to producingproperties for the year ended December 31, 2008 and 2007, respectively.

 

In2008, the Company also incurred costs of $12.4 million during the year ended December 31,2008 for the installation of sea-bed pipelines and a new mooring system as aresult of placing the FPSO into service and production equipment to supportoperations. This new program should enable BPZ to initiate production in amore efficient manner which will allow for a better understanding of the behaviorand characteristics of the Corvina oil field.

 

Inpreparation for the Company’s drilling campaign in Albacora, it performed wellcontrol on the three existing well heads located at the platform.  TheCompany incurred approximately $1.5 million in well control costs to provide asafe environment to begin the refurbishment of the A-1 platform.

 

Additionallyin 2008, the Company entered into two lease-purchase agreements to acquire theBPZ-02 barge and to acquire the production equipment used on board the Namokuresulting in additional capital assets of approximately $7.0 million and $2.4million, respectively. The leasing transactions are accounted for in accordancewith SFAS 13, “Accounting for Leases (As Amended)” (“SFAS 13”). Title to theBPZ-02 transfers to the Company at the end of the lease and the FPSO leasecontains a bargain purchase option; therefore, depreciation of both of theseleased assets will be over their useful life, in accordance with SFAS 13.Further the Company capitalized an additional $2.8 million of productionequipment in order to have the FPSO ready to receive and treat oil receivedfrom the CX-11 platform.

 

Forthe development of a Company owned gas-fired power generation facility, BPZincurred costs of approximately $3.6 million related to the drafting of certaindesign specifications for the power plant and capitalized an additional $9.0million incurred as part of its agreement to purchase three LM6000 gas-firedturbines, including an initial down payment of $5.1 million.

 

In2007, the Company entered into a capital lease agreement, with an option topurchase, for two barges to assist in the development of the Corvina oil. Thecapital lease assets were recorded at $6.2 million, which represents thepresent value of the minimum lease payments, or the aggregate fair market valueof the assets. Lease payments are variable based on the working status of thebarges with a purchase option of $5.0 million after the first year of the leaseand $4.0 million after the maturity date of the lease. The lease transaction isaccounted for in accordance with SFAS 13. The lease contains a bargain purchaseoption; therefore, depreciation of these leased assets will be over theiruseful life, in accordance with SFAS 13.

 

In2008 the Company incurred costs for office equipment and leasehold improvementsfor our offices in Houston, Peru and Ecuador of approximately $0.9 million andfor the purchase of machinery and equipment used in operations in Peru ofapproximately $0.7 million. In 2007 the Company incurred costs for officeequipment and leasehold improvements for our offices in Houston, Peru andEcuador of approximately $0.1 million and for the purchase of machinery andequipment used in operations in Peru of approximately $0.2 million.

 

For the year ended December 31, 2008, inaccordance with “successful efforts” method of accounting, we capitalizedapproximately $1.0 million of depreciation expense, mainly related to thetender assist barges serving as support equipment, and $4.2 million of interestexpense to construction in progress. For the year ended December 31, 2007,we capitalized approximately $0.5 million of depreciation expense and $0.9million of interest expense to construction in progress.

 

**Note 6 —Investment in Ecuador Property**

** **

The Company has a 10% net investment interestin an oil and gas property in Ecuador (the “Santa Elena Property”) totaling$1.4 million and $1.6 million as of December 31, 2008 and 2007,respectively. The Company accounts for this investment under the cost method andrecords its share of cash received or paid as other income or expense. Sincethe Company’s investment represents ownership of an oil and gas property, whichis a depleting asset, the Company is amortizing the cost of the investment on astraight-line basis over the remaining term of the license agreement whichexpires in May 2016. Accordingly, the Company recorded amortizationexpense of $0.2 million in each of the years ended December 31, 2008 and2007, respectively. Investment income from the Company’s investment in Ecuadorproperty was $0.7 million, $0.3 million and $1.4 million for each of the yearsending December 31, 2008, 2007 and 2006, respectively.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Note 7 —Restricted Cash**

** **

Asof December 31, 2008, the Company has restricted cash deposits of $5.1million, which partially collateralizes the insurance and performance bonds. Inconnection with the Company’s properties in Peru, it has obtained fourperformance bonds totaling $5.3 million that are partially collateralized byrestricted cash deposits of $2.9 million to insure certain performanceobligations and commitments under the license contracts for Blocks Z-1, XIX,XXII and XXIII. Additionally the Company has $2.2 million of restricted cash tocollateralize insurance bonds for import duties related to the FPSO andtransport tanker.

 

Duringthe year ended December 31, 2008, the Company was refunded $0.8 millionrelated to the second exploration phase under the Block XIX license contractand approximately $1.0 million related to a performance commitment under adrilling services contract.

 

Allof the performance bonds are issued by Peruvian banks and their terms aregoverned by the corresponding license contract.

 

In 2007, the Company had five performance bonds totaling$6.0 million to insure certain obligations and commitments, of which onerelates to a guarantee under a service contract and four relate to performanceobligations under the license contracts for Blocks Z-1, XIX, XXII and XXIII.

 

As of December 31,2007, the Companysecured a $1.0 million performance bond to guarantee payment under aservice agreement. Thebond expired in January 2008 at which time the cash was refunded. Accordingly theamount was recorded as a current asset at December 31, 2007.

 

Additionally,as of December 31, 2007, the Company had restricted cash deposits of $2.8 million, which partially collateralizes the performance bondsunder the License Contracts. In addition to the cash collateral posted by theCompany, an individual shareholder of the Company had provided a guarantee inthe amount of $200,000 to the financial institution that issued one of thebonds to secure the Company’s performance. During 2004, the Companyissued 236,528 shares to that individual investor for $119,175 of cash proceedsand a subscription receivable of $230,825 for the guarantee. During the year ended December 31, 2007, theguarantee was replaced by a deposit of an additional $95,000 by the Company tothe same financial institution and the Company received the $230,825 cashproceeds related to the subscription receivable. See, Note 15 “Commitment andContingencies” below for further details of our performance bondsobligation.

 

All of the performancebonds were issued by Peruvian banks and their terms are governed by thecorresponding license contract or technical evaluation agreement.

 

**Note 8 —AssetRetirement Obligation**

** **

An obligation was recorded for the plug and abandonment of theproducing oil wells, the CX11-21XD, CX11-14D, CX11-20XD and the CX11-18XD, inaccordance with the provisions of SFAS No 143 “Accounting for Asset RetirementObligations” (“ARO”).

 

***Activity related to the Company’s asset retirementobligation (“ARO”) for December 31, 2008 and 2007 is as follows:***

 

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**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 
| ** **                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |
| ARO as of the beginning of the period |       | $        | 273,048    |     | $          | — |   |
| Liabilities incurred during period    |       | 268,574  |       | 268,572  |       |
| Liabilities settled during period     |       | —   |       | —   |       |
| Accretion expense                     |       | 39,164   |       | 4,476    |       |
| ARO as of the end of the period       |       | $        | 580,786    |     | $          | 273,048 |   |

 

**Note 9 — Long-Term Debt and Capital Lease Obligations**

 

At December 31, 2008 and 2007 long-term debtand capital lease obligations consist of the following:

 
| ** **                                                           | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| $15 million IFC Senior Note, Libor plus  2.75%, due 2012             |       | $          | 15,000,000 |       | $          | — |   |
| $15 million IFC Senior Convertible Notes,  Libor plus 2.0%, due 2017 |       | —     |       | 15,500,000 |       |
| Capital Lease Obligations                                            |       | 7,837,419  |       | 6,225,961  |       |
|                                                                 |       | 22,837,419 |       | 21,725,961 |       |
| Less: Current Portion of Long-Term Debt                              |       | 7,819,908  |       | 6,188,668  |       |
|                                                                 |       | $          | 15,017,511 |       | $          | 15,537,293 |   |

 

The following is a summary of scheduled long-termdebt maturities by year:

 
| 2009      |   | $         | —     |   |
|-----------|--------|-----------|------------|--------|
| 2010      |   | 2,500,000 |       |
| 2011      |   | 5,000,000 |       |
| 2012      |   | 7,500,000 |       |
| 2013      |   | —    |       |
| Therafter |   | —    |       |
|      |   | $         | 15,000,000 |   |

 

The following is a summary of scheduled minimumlease payments under capital lease obligations by year:

 
| 2009                                                      |   | $          | 10,495,012 |   |
|-----------------------------------------------------------|--------|------------|------------|--------|
| 2010                                                      |   | 18,048     |       |
| 2011                                                      |   | —     |       |
| 2012                                                      |   | —     |       |
| 2013                                                      |   | —     |       |
| Therafter                                                 |   | —     |       |
| Total Minimum Lease Payments                              |   | 10,513,060 |       |
| Less: Amounts representing interest                       |   | 2,675,641  |       |
| Present Value of Minimum Lease Payments                   |   | 7,837,419  |       |
| Less: Current Portion of Obligations Under  Capital Lease |   | 7,819,908  |       |
| Long-Term Portion of Obligations Under  Capital Lease     |   | $          | 17,511     |   |

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

*$15.0Million IFC Reserve-Based Credit Facility*

* *

**On August 15,2008, the Company entered into a $15.0 million reserve-based lending facility (“$15.0million Senior Note”) agreement (the “Loan Agreement”) with**International Finance Corporation (“IFC”) through our subsidiaries BPZ Exploración &Producción S.R.L and BPZ Marine Peru S.R.L as borrowers.   The $15.0million Senior Note represents the first tranche of an expected overall lendingpackage of approximately $90.0 million.  The Company used a portion of theproceeds from the Senior Note for its initial $5.1 million down payment andsubsequent monthly progress payments for the GE turbines (see Note 1 — “Basisof Presentation and Significant Accounting Policies” for further information)The reserve-based lending facility matures in December 2012 and bearsinterest at an approximate rate of LIBOR plus 2.75%, currently equivalent to4.56% based on the current six month LIBOR rate of 1.81%.  The maximumamount available under this facility begins at $15.0 million and will bereduced by $2.5 million beginning on December 16, 2010 and every six monthsthereafter during the term of the Loan Agreement.  The amount availableunder the Loan Agreement is subject to a semi-annual borrowing basedetermination based on the value of oil reserves.  In addition, theCompany is subject to various financial covenants calculated as of the last dayof each quarter, including a life of field coverage ratio, life of loancoverage ratio, debt to equity ratio and interest cover ratio. The Company wasin compliance with all applicable covenants of the Loan Agreement as of December 31,2008.  Funding for the initial amounts available under the Loan Agreementwas subject to satisfying certain conditions precedent which were fulfilled on October 17,2008 and subsequently BPZ borrowed the entire $15.0 million available under theLoan Agreement.

** **

The Loan Agreement provides for events of default customary foragreements of this type, including, among other things, payment breaches underany of the finance documents for the first and second tranche of the seniordebt; failure to comply with obligations; representation and warranty breaches;expropriation of the assets, business or operations of any borrower;insolvencies of any borrower; certain attachments against the assets of anyborrower; failure to maintain certain authorizations with respect to anyfinancing documents with the IFC, the development and operation of the CorvinaField in Block Z-1, any additional petroleum assets under license contractswith Perupetro or certain other key agreements; revocation of any financing orsecurity documents with the IFC or certain key agreements; defaults on certainliabilities; certain judgments against the borrower or any subsidiary;abandonment or extended business interruption of the Corvina Field or certainother petroleum assets; engagement in certain sanctionable practices; orrestrictions are enacted in Peru that could inhibit any payment a borrower isrequired to make under the financing documents with the IFC.

 

If an event of default occurs, IFC and any additional facility agentmay (i) terminate all or part of the relevant facility; (ii) declareall or part of the principal amount of the loan, together with accruedinterest, immediately due and payable;  (iii) declare all or part ofthe principal amount of the loan, together with accrued interest, payable ondemand; or (iv) declare any and all of the security documents under thefacility enforceable and exercise its rights under such documents. In addition,if any borrower is liquidated or declared bankrupt, all loans and interestaccrued on it or any other amounts due, will become immediately due and payablewithout notice.

 

*$15.5Million Debt Conversion to Equity*

* *

OnNovember 19, 2007, a Convertible Debt Agreement between IFC and theCompany was entered into for approximately $15.5 million.  The terms ofthe loan agreement stipulate a conversion price of $10.39 per share and includea forced convert price of $18.19 per share, based on the average closing priceover twenty consecutive business days. The instrument had a 10 year term with avariable interest rate of 2.0% per annum above 6-month LIBOR. In May 2008,the Company elected to exercise its option to convert $15.5 million of convertible debt with the IFC intoapproximately 1.5 million shares of common stock.

 

*NotePayable*

* *

In January 2009, in exchange of receipt of $1.0million from an individual (“Note Holder”), the Company signed a promissorynote (the “Note”). TheNote matures in July 2009 and bears an annual interest rate of 12.0%.Interest payments are due monthly on the first day of each month the principalis outstanding. Additionally the terms of the Note include a conversionfeature, at the Company’s option, to deliver and exchange as consideration andpayment of the Note; shares of the Company’s common stock. The number of shareswill be determined by applying a 12% discount to the closing price of itsCommon Stock on the day prior to settlement. Further the Note Holder has theright to participate in any equity offering during the period the principal isoutstanding by tendering the Note for shares of common stock. The number ofshares will 

 

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**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

be determined by dividing the total outstanding indebtedness by theshare price of the offering on the same terms as other participants in theoffering. Should the Company default on any terms of the Note, it agreesdeliver its common stock, as consideration and payment of the Note, within 30days the date of default.

 

*CapitalLeases*

* *

InFebruary 2008, the Company entered into a lease-purchase agreement toacquire the deck barge BPZ-02 to assist in the platform refurbishment anddrilling activities in the Albacora field as well as to assist in futureoffshore drilling and development activities.  See Note 5 “Property,Equipment and Construction in Progress”, included herein, for furtherdiscussion.  The terms of the lease-purchase stipulate a 19% rate ofinterest (33% effective rate of interest) over a one-year term ending March 2009at which point, title to the BPZ-02 will transfer to the Company upon finalpayment of the lease.  The Company accounted for the transaction as a capitallease in accordance to SFAS No. 13, “Accounting for Leases (As Amended)”under the applicable criteria, title to the barge will transfer at the end ofthe lease period and, as a result, depreciation will be calculated over theeconomic life of the asset.  Lease payments are fixed at $694,167 permonth.  The capital lease asset was recorded at approximately $7.0million, which represents the lesser of the present value of the minimum leasepayments, or the fair marketvalue of the asset.

 

In2007 the Company entered into a capital lease agreement, with an option topurchase, for two barges (the Namoku, as well as the storage barge, the Nu’uanu) to assist in the development of the Corvina oil.  The capital lease forthe two barges began in August 2007 and expires in November 2009. Lease payments are variable, based on the working status of the barges, with apurchase option of $5,000,000 after the first year of the lease and $4,000,000after the maturity date of the lease.  The capital lease obligation wasrecorded at the present value of the minimum lease payments at an imputeddiscount rate of 18%, which reflects the Company’s incremental borrowing ratefor this transaction.  The capital lease obligation was recorded atapproximately $6.2 million, which represents lesser of the present value of theminimum lease payments, or the fair market value of the asset. As of December 31,2008, the Company has not elected to purchase the barges under the terms of thefirst year purchase option.

 

Inconnection with the Namoku lease, the Company entered into a separate capitallease agreement for the production equipment used on board the Namoku for theFPSO. The capital lease for the production equipment commenced in June 2008,the date the equipment was put into service.  The lease terms are variableand bears an interest rate of 18% based on the Company’s incremental borrowingrate for similar equipment.  In accordance with the terms of the lease, abargain purchase option exists at the end of the lease.  As a result,depreciation will be calculated over the economic life of the asset.  TheCompany recorded the capital lease at $2.4 million, which represents the lesserof the present value of the minimum lease payments, or the fair market value ofthe asset.

 

In2007, the Company entered into two capital loans for the purchase of officefurniture.  Both loans have a term of 60 months, bearing interest at 5.94%and 9.44%, respectively, with principal and interest payments due on a monthlybasis.

 

InMarch 2008, the Company entered into two loan agreements with Peruvianbanks to borrow approximately $2.8 million.  The loans were collateralizedby IGV receivables and bore interest rates of approximately 8% each.  TheCompany repaid the remaining outstanding balance in August 2008.

 

**Note 10 —Stockholders’ Equity**

** **

The Company has 25,000,000 shares ofpreferred stock, no par value and 250,000,000 shares of common stock, no parvalue, authorized for issuance.

 

**2009Private Placement of Common Stock**

** **

On February 13, 2009, the Company announced its intent to sellapproximately 15.7 million of its common stock shares to institutionalinvestors at a price of $3.05 per share for gross proceeds of approximately $48million. On February 23, 2009, the Company closed the private placement ofapproximately14.3 million shares of common stock, no par value, toinstitutional and accredited investors pursuant to a Stock Purchase Agreementdated February 19, 2009. Additionally, the IFC holds a right to elect toparticipate in the offering resulting in the possible sale of an additional 1.4million shares of common stock for a total of up to approximately 15.7 millionshares of common stock sold in this private offering. The common stock 

 

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**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

was priced at $3.05 per shareresulting in gross proceeds to the Company of approximately $43.6 million($48.0 million if the IFC elects to participate in the offering). No warrantsor other dilutive securities were issued to the investors in connection withthe private placement.

 

The shares wereplaced directly by Pritchard Capital Partners, LLC and the Company has agreedto a 5% cash placement fee of the gross proceeds at each closing. Additionally, the Company retained Morgan Keegan & Company, Inc.,as its financial advisor, in connection with the offering.  In return forits services, Morgan Keegan & Company, Inc. will receive anadvisory fee of 1.5% of the gross proceeds of this transaction at each closing.

 

Underthe Stock Purchase Agreement, the Company committed to file a registrationstatement with the SEC covering the shares no later than 45 days after theclosing with respect to such shares, and will use its reasonable best effortsto obtain its effectiveness no later than the earlier of (i) 90 days afterthe closing with respect to such shares, or in the event of SEC review of theregistration statement, 120 days after the closing and (ii) the thirdbusiness day following the date on which the Company is notified (orally or inwriting, whichever is earlier) by the SEC that the registration statement willnot be reviewed or is no longer subject to further review and comment. The Company is subject to a potential maximum aggregate penalty of 13% of thegross proceeds of the offering or approximately $5.7 million, excluding the IFC’sparticipation, if the registration statement related to the offering is notfiled or declared effective within the time-frames outlined above.  At theCompany’s option, any penalties would be payable in cash or common stock of theCompany.

 

Following theclosing of this private placement, the Company has 93,054,150 shares of commonstock issued and outstanding, with fully diluted shares of 96,948,498,excluding the 1.4 million shares the IFC may elect to purchase as part of theoffering, respectively. The fully diluted shares include the potential effect of vested andunvested options and restricted stock outstanding.

 

**2008 PublicOffering of Common Stock**

 

On March 25, 2008 theCompany completed an offering of 2.0 million shares of its common stock, no parvalue, under an effective registration statement, with an additional 0.2million share over-allotment purchase of common stock that closed on April 21,2008. The shares of common stock for the offering, including shares of commonstock for the over-allotment, was priced at $20.00 per share resulting in netproceeds to the Company, after underwriting fees and discounts, of approximately $41.3 million.No warrants or dilutive securities were issued in connection with the offering.A financial advisoryfee of $150,000 was paid to Morgan Keegan for investment services andconsulting related to the offering.

 

**Conversionof Debt to Equity**

** **

In May 2008, theCompany elected to exercise its option to convert $15.5 million of debt with the IFC intoapproximately1.5 million shares of common stock. The terms of the ConvertibleDebt Agreement, dated November 19, 2007, stipulate a conversion price of$10.39 per share and include a forced conversion, exercisable at the Company’soption, if the closing price of the Company’s common stock exceeds a price of$18.19 per share based on the average closing price over a period of twentyconsecutive business days. See Note 9, “Long-Term Debt and Capital LeaseObligations” for further information.

 

**Warrants**

 

In 2007, the Company had 250,000 warrants outstanding. For their roleas placement agent, in connection with the private placement of 11,466,000shares of common stock in July 2005, Morgan Keegan & Company, Inc.received fully vested warrants to purchase 100,000 shares of the Company’scommon 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.

 

Additionally, for their financial advisory services, in connection withthe private placement of 4,482,000 shares of common stock in June 2006,Morgan Keegan & Company, Inc. received fully vested warrants to purchase150,000 shares of the Company’s common stock at an exercise price of $3.00 pershare. Such warrants expire on June 30, 2011. These warrants were valuedat $248,645 using the Black-Scholes model, which amount was treated asadditional non-cash stock offering costs.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

Duringthe year ended December 31, 2008, Morgan Keegan exercised warrants topurchase 250,000 shares of the Company’s common stock at an exercise price of$3.00.  As a result, the Company received proceeds of $750,000.

 

**PotentiallyDilutive Securities**

** **

In addition to the sharesissued and outstanding, the Company has the following potentially dilutivesecurities at December 31, 2008, 2007 and 2006. None of these potentiallydilutive shares have been included in the calculation of earnings per share asthe effect would be anti-dilutive.

 
| ** **                                                          | ** ** | **2008**  | ** ** | **2007**  | ** ** | **2006**   | ** ** |
|---------------------------------------------------------------------|------------|-----------|------------|-----------|------------|------------|------------|
| Stock options outstanding                                           |       | 3,894,348 |       | 4,175,448 |       | 4,306,152  |       |
| Warrants outstanding                                                |       | —    |       | 250,000   |       | 250,000    |       |
| Contingent incentive earn-out shares                                |       | —    |       | —    |       | 450,000    |       |
| Contingent Merger earn-out shares                                   |       | —    |       | —    |       | 9,000,000  |       |
| Shares issuable under IFC convertible debt  agreement               |       | —    |       | 1,491,819 |       | —     |       |
| Total potentially dilutive securities  issued                       |       | 3,894,348 |       | 5,917,267 |       | 14,006,152 |       |
|                                                                |       |      |       |      |       |       |       |
| Shares available pursuant to Long-Term  Incentive Compensation Plan |       | 2,541,450 |       | 3,152,450 |       | 1,156,000  |       |

 

On January 1, 2006, the Company adopted SFAS No. 123(R),*”*Share Based Payment” (“SFAS No. 123(R)”),which establishes accounting for stock-based payment transactions for employeeservices and goods and services received from non-employees. SFAS No. 123(R) isa revision of SFAS No. 123, “Accounting for Stock-Based Compensation”, andsupersedes APB No. 25, “Accounting for Stock Issued to Employees”. Underthe provisions of SFAS No. 123(R), stock-based compensation cost ismeasured at the date of grant, based on the calculated fair value of the award,and is recognized as expense in the Consolidated Statements of Operationsratably over the employee’s or non-employee’s requisite service period, whichis generally the vesting period of the equity grant. Additionally, stock-basedcompensation cost is recognized based on awards that are ultimately expected tovest, therefore, the compensation cost recognized on stock-based paymenttransactions is reduced for estimated forfeitures based on the Company’shistorical forfeiture rates.

 

The Company adopted SFAS No. 123(R) using the modifiedprospective application method and, accordingly, no prior periods have beenrestated as a result of the adoption of this pronouncement. The modified prospective method requiresrecognition of compensation expense for stock-based payment awards that aregranted, modified, repurchased or cancelled after 2005. Compensation expensefor unvested stock options outstanding as of January 1, 2006 for which therequisite service has not been rendered is being recognized over the remainingservice period using the compensation cost previously calculated for pro formadisclosure purposes under SFAS No. 123.

 

Priorto the adoption of SFAS 123(R), the Company presented all tax benefits ofdeductions resulting from the exercise of options as operating cash flows inthe Statement of Consolidated Cash Flows. SFAS 123(R) requires the cashflows resulting from tax deductions in excess of the compensation costrecognized for those options (excess tax benefits) to be classified asfinancing cash flows. However, as the Company is not able to use these taxdeductions (see Note 13, “Income Taxes” for further information), it has noexcess tax benefits to be classified as financing cash flows.

 

SFAS No. 123(R) requiresall stock-based compensation related to unvested stock awards, including stockoptions, to be recognized by the Company as an operating expense. Stock-basedcompensation expense for all share-based arrangements is primarily recorded in “Generaland Administrative” expenses in the accompanying Consolidated Statements ofOperations. Additionally, no stock-based compensation costs were capitalizedfor the year ended December 31, 2008, 2007 and 2006. The Company providescompensation benefits to employees and non-employee directors under share-basedpayment arrangements, including various employee stock option plans.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

The following table summarizes stock-based compensation costsrecognized under SFAS 123(R) for year ended December 31:

 
| ** **                                   | ** ** | **2008**  | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|----------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                         |       |      |       |      |       |      |       |
| Employee stock—based compensation costs |       | $         | 12,697,861 |      | $          | 5,592,473 |       | $ | 2,657,149 |   |
| Director stock-based compensation            |       | 5,765,902 |       | 1,447,130 |       | 568,359   |       |
|                                         |       | $         | 18,463,763 |      | $          | 7,039,603 |       | $ | 3,225,508 |   |

 

**Stock Option and Restricted Stock Plans**

 

The Company has in effect the 2007 Long-Term Incentive CompensationPlan (the “2007 LTIP”), which is an amendment and restatement of the BPZ Energy, Inc.2005 Long-Term Incentive Compensation Plan (the “2005 LTIP”). The 2007 LTIPprovides for awards of options, stock appreciation rights, restricted stock,restricted stock units, performance awards, other stock-based awards andcash-based awards to any of the Company’s officers, employees, consultant andthe employees of certain of the Company’s affiliates The provisions of eachaward will vary based on the type of award granted and will be specified by theCompensation Committee of the Board of Directors. The aggregate number ofshares of Common Stock authorized for grant under the 2007 LTIP is4.0 million. The Company normally issues new shares of its Common Stock insatisfaction of these awards. As of December 31, 2008, 916,450 sharesremain available for future grants under the Plan,

 

The Company also has in effect the separate 2007 Directors’Compensation Incentive Plan (the “Directors’ Plan”), which is an amendment andrestatement of the BPZ Energy, Inc. 2005 Long-Term Incentive CompensationPlan (the “2005 LTIP”) applicable to directors. The Directors’ Plan providesfor awards of options, stock appreciation rights, restricted stock, restrictedstock units, performance awards, other stock-based awards and cash-based awardsto any non-employee director. The provisions of each award will vary based onthe type of award granted and will be specified by the Compensation Committeeof the Board of Directors. The aggregate number of shares of Common Stockauthorized for grant under the Directors’ Plan is 2.5 million. The Companynormally issues new shares of its Common Stock in satisfaction of these awards.As of December 31, 2008, 1,625,000 shares remain available for futuregrants under the Plan,

 

**Restricted Stock Awards and PerformanceShares**

 

At December 31, 2008, there were approximately865,350 shares of restricted stock awards outstanding to officers,directors and employees all of which generally vest with the passage of time onthe second or third anniversary of the date of grant. Restricted stock is subjectto certain restrictions on ownership and transferability when granted. The fairvalue of restricted stock awards is based on the market price of the CommonStock on the date of grant. Compensation cost for such awards isrecognized ratably over the vesting or service period, net of forfeitures;however, compensation cost related to performance shares will not be recordedor will be reversed if the Company does not believe it is probable that suchperformance criteria will be met or if the service provider (employee orotherwise) fails to meet such criteria.

 

A summary of the Company’s restricted stockaward activity for the year ended December 31, 2008 andrelated information is presented below:

 
| ** **                              | ** ** | ** **         | ** ** | **Weighted—**  | ** ** |
|-----------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                              | ** ** | **Number of** | ** ** | **Average**         | ** ** |
| ** **                              | ** ** | **Restricted**     | ** ** | **Fair Value** | ** ** |
| ** **                              | ** ** | **Shares**         | ** ** | **Per Share**  | ** ** |
| Outstanding at the begining of the year |       | 1,284,850          |       | $                   | 8.82       |   |
| Granted                                 |       | —             |       | $                   | —     |   |
| Vested                                  |       | (408,500           | )          | $                   | 4.42       |   |
| Forfeited                               |       | (11,000            | )          | $                   | 4.10       |   |
| Outstanding at the end of the year      |       | 865,350            |       | $                   | 10.95      |   |

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

The weighted average grant-date fair value ofrestricted stock awards granted for the years ended December 31, 2007 and2006 was $8.73 and $3.44, respectively. The fair value of restricted stockawards that vested during the years ended December 31, 2008, 2007 and 2006was $6.7 million, $5.9 million and $1.1 million, respectively. Asof December 31, 2008, there was $6.0 million of total unrecognizedcompensation cost related to nonvested restricted stock awards, which isexpected to be recognized over a weighted-average period of 1.2 years.

 

**Stock Options**

 

Incentive and non-qualified stock optionsissued to directors, officers, employees and consultants are typicallygranted at the fair market value on the date of grant. The Company’sstock options generally vest inequal annual installments over a two to three year period and expire tenyears from the date of grant.

 

The fair value of each stock option grantedis estimated on the date of grant using a Black-Scholes option pricing model.The Black-Scholes option valuation model was developed for use in estimatingthe fair value of traded options, which have no vesting restrictions and arefully transferable and negotiable in a free trading market. This model does notconsider the employment, transfer or vesting restrictions that are inherent inthe Company’s stock options.

 

Use of an option valuation model includeshighly subjective assumptions based on long-term predictions, including theexpected stock price volatility and expected option term of each stock option grant.

 

The following table presents theweighted-average assumptions used in the option pricing model for optionsgranted during the year ended December 31:

 
| ** **                                           | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Expected life (years) (a)                            |       | 5        |       | 6        |       | 6        |       |
| Risk-free interest rate (c)                          |       | 4        | %          | 4        | %          | 5        | %          |
| Volatility (b)                                       |       | 80.97    | %          | 82.31    | %          | 72.27    | %          |
| Dividend yield (d)                                   |       | 0        | %          | 0        | %          | 0        | %          |
| Weighted-average fair value per share at  grant date |       | $        | 14.48      |     | $          | 7.07     |       | $ | 2.37 |   |
|                                                      |            |          |            |          |            |          |            |  |  |  |

 

----

(a)          The expected life was derived based on a weighting between (a) theCompany’s historical exercise and forfeiture activity and (b) the averagemidpoint between vesting and the contractual term and (c) from theanalysis of other companies of a similar size and operational life cycle.

 

(b)         The volatility is based on the historical volatility of our stock for aperiod approximating the expected life.

 

(c)          The risk-free interest rate is based on the observed U.S.  Treasuryyield curve in effect at the time the options were granted.

 

(d)         The dividend yield is based on the fact the Company does not anticipatepaying any dividends.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

A summary of our stock option activity forthe year ended December 31, 2008 and related information is presentedbelow:

 
| ** **                              | ** ** | ** **         | ** ** | ** **              | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|-----------------------------------------|------------|--------------------|------------|-------------------------|------------|-----------------|------------|---------------|------------|
| ** **                              | ** ** | ** **         | ** ** | **Weighted—**      | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                              | ** ** | ** **         | ** ** | **Average**             | ** ** | **Remaining**   | ** ** | **Aggregate** | ** ** |
| ** **                              | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** | **Contractual** | ** ** | **Intrinsic** | ** ** |
| ** **                              | ** ** | **Options**        | ** ** | **Per Option**     | ** ** | **Term**        | ** ** | **Value**     | ** ** |
| Outstanding at the begining of the year |       | 4,175,448          |       | $                       | 8.14       |            |       |          |       |   |
| Granted                                 |       | 634,500            |       | $                       | 22.69      |            |       |          |       |   |
| Exercised                               |       | (903,100           | )          | $                       | 2.73       |            |       |          |       |   |
| Forfeited                               |       | (12,500            | )          | $                       | 7.30       |            |       |          |       |   |
| Outstanding at the end of the year      |       | 3,894,348          |       | $                       | 10.03      |            | 8.23       |          | $          | 4,242,225.00 |   |
|                                    |       |               |       |                    |       |            |       |          |       |
| Exercisable at the end of the year      |       | 1,545,055          |       | $                       | 4.89       |            | 8.03       |          | $          | 3,843,975.00 |   |

 

As of December 31, 2008, there was$10.3 million of unrecognized compensation cost related to non-vested stock options thatis expected to be recognized over a weighted average period of 1.3 years.The total intrinsic value of stock options (defined as the amount by which themarket price of the Common Stock on the date of exercise exceeds the exerciseprice of the stock option) exercised during the years ended December 31,2008 and 2007 was $16.0 million, $9.7 million, respectively. Cashreceived from stock option exercises for the years ended December 31, 2008and 2007 was $2.4 million and $3.4 million, respectively. No optionswere exercised in 2006.

 

Additional compensation expense of $0.7million was recognized for the year ended December 31, 2008 primarilyrelated to accelerated vesting for certain stock option awards.

 

The following table summarizes informationabout stock options outstanding as of December 31, 2008:

 
| ** **                                  | ** ** | **Outstanding**    | ** ** | **Exercisable**     | ** ** |
|---------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                  | ** ** | ** **         | ** ** | **Weighted-**       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **         | ** ** | **Average**         | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **         | ** ** | **Remaining**       | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                  | ** ** | ** **         | ** ** | **Contractual**     | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | **Number of** | ** ** | **Life**            | ** ** | **Weighted** | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| **Range of Exercise Prices** | ** ** | **Options(1)**     | ** ** | **(In years)** | ** ** | **Exercise Price** | ** ** | **Options** | ** ** | **Per Option** | ** ** |
| Below                                       | to         | $2.12              |       | 99,248              |       | 5.7 |   | $ | 1.30 |   | 99,248 |   | $ | 1.30 |   |
| $2.13                                       | to         | $4.23              |       | 950,000             |       | 7.4 |   | $ | 3.41 |   | 950,000 |   | $ | 3.41 |   |
| $4.24                                       | to         | $6.35              |       | 611,000             |       | 8.5 |   | $ | 4.94 |   | 318,169 |   | $ | 4.84 |   |
| $6.36                                       | to         | $8.47              |       | 120,900             |       | 8.3 |   | $ | 6.50 |   | 39,238 |   | $ | 6.50 |   |
| $8.48                                       | to         | $10.58             |       | 251,200             |       | 9.0 |   | $ | 10.22 |   | 70,400 |   | $ | 10.43 |   |
| $10.59                                      | to         | $11.88             |       | 1,862,000           |       | 8.6 |   | $ | 15.75 |   | 68,000 |   | $ | 24.36 |   |
| Total                                       |       | 3,894,348          |       | 8.2                 |       | $ | 10.03 |   | 1,545,055 |   | $ | 4.89 |   |

 

**Private Placements of CommonStock**

 

On May 4, 2007, with anover-allotment purchase that closed on June 15, 2007, the Companycompleted a private placement of 7,170,000 shares of common stock, no parvalue, to accredited investors pursuant to a Subscription Agreement. The commonstock was priced at $5.25 per share and the over-allotment was priced at $5.40per share resulting in proceeds to the Company of approximately $37.7 million.No warrants or dilutive securities were issued in connection with the offering.The offering was placed directly by the Company. A placement fee of 2% of thegross proceeds of this transaction was paid to Morgan Keegan for investmentservices and consulting related to the offering. The registration statement wasdeclared effective by the Securities and Exchange Commission on June 20,2007.

 

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**BPZ RESOURCES,INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Stock SubscriptionReceivable**

** **

During 2004, the Company issued 236,528shares to an individual investor for $119,175 of cash proceeds and asubscription receivable of $230,825 for a guarantee letter. The guarantee letter wasassociated with the first exploration phase of Block Z-1. During the year endedDecember 31, 2007, the guarantee was replaced by a deposit of anadditional $95,000 by the Company to the same financial institution.Additionally, during 2007 the Company received the $230,825 cash proceedsrelated to the subscription receivable. See Note 7 “Restricted Cash”, includedherein, for further discussion.

 

**ContingentIncentive Earn-Out Shares**

 

During 2005, the Company’s Board of Directors awarded a total of485,000 shares of incentive stock awards to three of the Company’s officers.The incentive stock awards vest and the earn-out shares are issuable once theCompany is entitled to receive as its proportionate share from gross productionfrom any oil and gas wells owned or operated by the Company not less than 2,000barrels of oil per day or its equivalent (approximately 12 million cubic feetof gas per day) prior to December 28, 2007, the same target applicable tothe Merger earn-out shares (see immediately below). However, one of the Company’sofficers entitled to receive earn-out shares resigned from the Company and itssubsidiaries effective June 15, 2006, and as a result 225,000 of theunvested contingent incentive stock awards, representing $990,000 of futurepossible compensation expense, were forfeited. Subsequently, 190,000 shares ofthose 225,000 shares were awarded to the officer’s successor to supplement aprevious award of 35,000 shares. The second earn-out targetprovided for in the original merger agreement related to its merger withNavidec, Inc. In November 2007, the production target in the MergerAgreement dated July 8, 2004 was achieved. The determination was made bythe Company’s Board of Directors based on certification by the independentengineering firm that the Company’s production in Peru has met or exceeded therequired level of production.

 

The achievement of the required level ofproduction resulted in the issuance of 450,000 shares. For accounting purposes,duringthe year ended December 31, 2007, $1,980,000 was recorded as compensationexpense.

 

**Merger Earn-Out Shares — Stock Dividend**

** **

Under the terms of the Merger Agreement, the Company committed to issue18,000,000 shares to the former shareholders of BPZ-Texas on a contingentearn-out basis if the Company achieved certain reserve and production goals.The first earn-out target relating to reserves was achieved in December 2004and 9,000,000 of the earn-out shares were issued. The remaining 9,000,000earn-out shares were contingent on the Company becoming entitled to receive asits proportionate share from gross production from any oil and gas wells ownedor operated by the Company not less than 2,000 barrels of oil per day or itsequivalent (approximately 12 million cubic feet of gas per day) prior to December 28,2007. As mentioned above, in November 2007 the productiontarget was achieved based on certification by an independent engineering firmthat the Company’s production in Peru has met or exceeded the required level ofproduction.

 

For accounting purposes, the earn-out arrangement is treated as a stockdividend because the earn-out is payable to the shareholders of the accountingacquirer, BPZ-Texas. Accordingly, except for a retroactive increase in thenumber of common shares outstanding for all periods presented, no accountingentry is required upon the issuance of the earn-out shares.

 

**Note 11 —Affiliate and Related Party Transactions**

** **

As of December 31,2008 and December 31, 2007, the Company had not entered into anytransactions with affiliates or related parties.

 

**Note 12 — Revenue**

** **

TheCompany began producing oil on a limited basis in November 2007 from theCX11-21XD and CX11-14D wells in the Corvina Field under an extended welltesting program.  During the second and fourth quarter of 2008, it addedproduction from the CX11-18XD and CX20-20XD wells under the extended welltesting program.  The oil is delivered by barge to the Petroperu refineryin Talara, located approximately 70 miles south of the platform. Produced oil is kept in production inventory until the Company increases theinventory quantities to a sufficient level that the refinery in Talara willaccept delivery.  The Company has entered into two contracts for the saleof oil to Petroperu since it began oil production in 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

November 2007.  Thefirst contract was for the sale of up to 200,000 barrels of oil to the refineryin Talara.  The contract was fulfilled in June 2008.  Thecurrent sales contract with Petroperu is for the delivery of up to 400,000barrels of oil to the Talara refinery.  Similar to the first salescontract, the current sales contract is based on Northwest Oil Basket pricingwhich is comprised of Oman, Fortes and Suez Blend pricing.  The unadjustedsales price is based on the past five day average before the crude oil deliverydate.  The price is then discounted for the quality of the oildelivered.  The determination of quality is based on the gravity of theoil expressed in degrees, as determined under standards established by theAmerican Petroleum Institute (“API”).  The price is discounted at a rateof 0.53% of the basket price per one degree API lower than the benchmark of 33degrees API as stipulated in the contract.  In addition, a fixed premiumof $0.75 per barrel is added to the price as a result of the high dieselcontent of the crude oil.

 

Subsequentto December 31, 2008, the Company, through its wholly-owned subsidiary BPZExploración & Producción S.R.L., entered into a long-term oil supplyagreement with Petroperu. Under the terms of the contract, the Company agreesto sell, and Petroperu agrees to purchase, all of the Company’s crude oilproduction originating from the Corvina oilfield in Block Z-1. The contractterm is for approximately seven years or until 17 million barrels of crude oilhas been delivered to the Petroperu refinery located in Talara, whichever comesfirst. The price per barrel of oil under the agreement is determined using abasket of crude oils based on a 15-day average of Forties, Oman, and Suez blendcrude oil prices, as quoted in the Spot Crude Prices Assessment published inPlatt’s Crude Oilgram Price Report, minus $1 per barrel and other customarypurchase price adjustments.

 

 Duringthe year ended December 31, 2008 and 2007 the Company sold approximately825,845 barrels and 28,741 barrels at an average price, net of royalties, ofapproximately $76.23 per barrel and $81.78, respectively.  The Company hadno oil sales during the year ended December 31, 2006. In January 2008,BPZ incurred production and transportation delays due to the incident involvingone of the Peruvian Navy tankers used in its oil production process. See Note1, “Basis of Presentation and Significant Accounting Policies — Corvina” abovefor a more detailed discussion of the incident. ** ** Approximately 1,300 barrels of oil were lost in thefire aboard the tanker.  The cost of the crude oil lost was approximately$62,000 and was expensed through lease operating expense and depreciation,depletion and amortization.

 

TheCompany’s net revenues exclude the cost of royalties owed to the government ofPeru. Royalties are calculated by Perupetro as stipulated in the Block Z-1license agreement based on the same Northwest Oil Basket discussed above,however, their calculation is based on the past two week average price beforethe crude oil delivery date, as opposed to being based on the past five-dayaverage price before the crude oil delivery date. For the year ended December 31,2008 and 2007, the revenues received by the Company are net of royalty costs ofapproximately 5% of gross revenues or $3.3 million and $0.1 million,respectively.

 

**Note 13 — IncomeTaxes**

** **

As of December 31, 2008, the Company had avaluation allowance for the full amount of the domestic deferred tax assetresulting from the income tax benefit generated from net losses, as itbelieves, based on the weight of available evidence, that it is more likelythan not that the deferred tax asset will not be realized prior to theexpiration of net operating loss carryforwards in various amounts through2027.  However, the Company is subject to Peruvian income tax on itsearnings at a statutory rate, as defined in the Block Z-1 License Contract, of22%.  Because the Company is under an extended well testing program fromwhich it will finalize a development plan for Block Z-1, it has not moved intothe commercial phase of production as defined by the license contract.  Assuch, certain deductions are disallowed by the Peruvian tax regime while theCompany operates under the extended well testing program.  In addition,the tax provision is based on taxable Peruvian income that excludes certainU.S. expenses that are not deductible at the Peruvian level. As a result, theCompany recognized a total tax provision for the year ended December 31,2008 of approximately $3,141,851.

 

Estimated interest and penalties related to potentialunderpayment on unrecognized tax benefits, if any, are classified as acomponent of tax expense in the Consolidated Statement of Operations. As of thedate of adoption of FIN 48, the Company did not have any accrued interest orpenalties associated with any unrecognized tax benefits, nor was any interestexpense recognized during the year.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

The source of income (loss) before income taxexpense/(benefit)  for the years ended December 31,2008, 2007 and 2006 is as follows:

 
| ** **                                           | ** ** | **2008**   | ** **  | **2007**   | ** ** | **2006**    | ** ** |
|------------------------------------------------------|------------|------------|-------------|------------|------------|-------------|------------|
| United States                                        |       | $          | (28,121,651 | )          | $          | (12,922,310 | )          | $ | (11,627,018 | ) |
| Foreign                                              |       | 21,617,014 |        | (7,548,671 | )          | (3,860,441  | )          |
| Loss from continuing operations before  income taxes |       | $          | (6,504,637  | )          | $          | (20,470,981 | )          | $ | (15,487,459 | ) |

 

The income tax expense/(benefit) differs fromthe amount computed by applying the U.S. statutory rate for the applicable yearto consolidated net loss before taxes as follows:

 
| ** **                                                       | ** ** | **2008**   | ** ** | **2007**  | ** ** | **2006**   | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-----------|------------|------------|------------|
| Federal statutory income tax rate                                |       | $          | (2,211,576 | )         | $          | (7,139,493 | )          | $ | (5,242,737 | ) |
| Increases (decreases) resulting from:                            |       |       |       |      |       |       |       |
| Non-deductible stock compensation expense                        |       | 6,550,722  |       | 3,653,338 |       | —     |       |
| Tax effect of Peru conversion to permanent  establishment status |       | 7,642,249  |       | —    |       | —     |       |
| Change in domestic valuation allowance                           |       | (8,839,544 | )          | 3,525,156 |       | 5,242,737  |       |
|                                                             |       | $          | 3,141,851  |      | $          | 39,001     |       | $ | — |   |

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

The tax effects of the temporary differencesthat give rise to the significant portion of the deferred tax assets andliabilities at December 31, 2008, 2007 and 2006 are presented below:

 
| ** **                        | ** ** | **2008**    | ** ** | **2007**    | ** ** | **2006**    | ** ** |
|-----------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Deferred Tax:                     |       |        |       |        |       |        |       |
| Asset:                            |       |        |       |        |       |        |       |
| Net Operating Loss                |       | $           | 19,941,250 |        | $          | 12,088,891  |       | $ | 8,885,175 |   |
| Deferred Compensation             |       | 1,889,109   |       | 6,360,268   |       | 3,966,804   |       |
| Asset Basis Difference            |       | —      |       | 709,140     |       | —      |       |
| Exploration Expense               |       | 2,079,853   |       | —      |       | —      |       |
| Depreciation                      |       | 12,409      |       | —      |       | —      |       |
| Depletion                         |       | 3,339,664   |       | —      |       | —      |       |
| Asset Retirement Obligation       |       | 26,869      |       | —      |       | —      |       |
| Other                             |       | 665,527     |       | —      |       | —      |       |
| Liability:                        |       |        |       |        |       |        |       |
| Preoperation Expenses             |       | (294,607    | )          | —      |       | —      |       |
| Asset Basis Difference            |       | (1,297,609  | )          | —      |       | —      |       |
| Other                             |       | (300,859    | )          | —      |       | —      |       |
| Net Deferred Tax Asset            |       | $           | 26,061,606 |        | $          | 19,158,299  |       | $ | 12,851,979 |   |
|                              |       |        |       |        |       |        |       |
| Less Domestic Valuation Allowance |       | (21,190,066 | )          | (19,158,299 | )          | (12,851,979 | )          |
| Deferred Tax Asset                |       | $           | 4,871,540  |        | $          | —      |       | $ | — |   |

 

**Note 14 — Business Segment Information**

 

The Company determines and discloses itssegments in accordance with SFAS No. 131 “Disclosures about Segments of anEnterprise and Related Information” which uses a “management” approach fordetermining segments. The management approach designates the internalorganization that is used by management for making operating decisions andassessing parlance as the source of the Company’s reportable segments. SFAS No. 131also requires disclosures about products or services, geographic areas, andmajor customers. The Company’s management reporting structure provided for onlyone segment for the years ended December 31, 2008, 2007 and 2006 andaccordingly, no separate segment information is presented. In addition, theCompany operates only in Peru and has only one customer for its oil production.The majority of our long-lived assets are located in Peru.

 

**Note15 — Commitments and Contingencies**

** **

*ProfitSharing*

 

The Constitution of Peru and LegislativeDecree Nos. 677 and 892 gives Peru employees working in private companiesengaged in activities generating income classified as third category income bythe Income Tax Law the right to share in the Company’s Peruvian subsidiariesprofits. The rate set for oil and gas companies is 5% of net income subject totaxation. The 5% of net income is determined by calculating a percentage of theCompany’s Peruvian subsidiaries annual total revenues subject to income taxless the expenses required to produce revenue or maintain the source ofrevenues. The benefit granted by the law to employees is calculated on thebasis of the “income subject to taxation” per the Peruvian tax code and not thereported net accounting of income of companies. For the year ended December 31,2008, approximately $1.9 million of expense related to profit sharing isincluded in “General and administrative expenses” in the Consolidated 

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

Statement of Operations and isdue to the Company’s Peru employees in April 2009. No profit sharing wasincurred by the Company for 2007 or 2006. The Company will be subject to profitsharing expense each year its Peruvian subsidiaries are profitable.

 

*BargeIncident*

 

Inearly August 2006, the Company incurred an operational delay resultingfrom a navigation incident which caused the BPZ-01 barge to be grounded on asand bank in Talara Bay in northwest Peru.  As of December 31, 2008,the Company recorded approximately $0.7 million in insurance receivable pendingthe submission of an insurance claim estimated to be approximately $0.8million.  A deductible of $75,000 will be applied to this insurance claimwhen reimbursed.

 

TheCompany received proceeds from its underwriter to cover a related claimregarding third party cargo that had been damaged in the grounding incidentmentioned above.  During the year ended December 31, 2008,approximately $80,000 of insurance proceeds were received in connection withthis claim.  A deductible of $25,000 was offset against the insuranceproceeds received.  This amount is unrelated to the $0.8 million hullclaim described above as the proceeds from the cargo claim was to the third partyowner of the cargo that was damaged.  The hull claim will be finalizedupon the dry docking of the vessel.  Because of the delays caused by thedrilling of the highly deviated CX11-20XD well during the third quarter 2008,the dry dock of the BPZ-01 is scheduled during the last quarter of 2009. As of December 31, 2008, the Company has not presented a final claim toits insurance carrier for the barge repairs.

 

TheCompany believes that the majority of the costs associated with the groundingincident will be reimbursed through insurance or through a third party. No assurances can be given, however, that any such recoveries will besufficient to cover all costs associated with the incident or to the timing ofany such recoveries.  The Company intends to file an insurance claim withour underwriters after it has fully assessed the damages and estimated repaircosts as well as finalized the reimbursement agreement with the third party.

 

*PeruProperties*

 

Inconnection with our properties in Peru, we have obtained four performance bondstotaling $5.3 million that are partially collateralized by restricted cashdeposits of $2.9 million to insure certain performance obligations andcommitments under the license contracts for Blocks Z-1, XIX, XXII and XXIII.Additionally, we have $2.2 million of restricted cash to collateralizeinsurance bonds for import duties related to the FPSO and transport tanker. Asof December 31, 2008, we had restricted cash deposits of $5.1 million,which partially collateralizes the insurance and performance bonds. SeeNote 8, “Restricted Cash and Performance Bonds” for further discussion.

 

*CapitalLease of Barge and Production Equipment*

 

InFebruary 2008, the Company entered into a lease-purchase agreement toacquire a deck barge (“BPZ-02”) to assist in the platform refurbishment anddrilling activities in the Albacora field as well as to assist in futureoffshore drilling and development activities.  In the near term, theBPZ-02 will be used to act as a tender assist for the Albacora platformrefurbishment and support for the Albacora drilling operations.  Theacquisition of the BPZ-02 allows the Company better asset maintenancescheduling and will aid in the support of increased offshore exploration anddevelopment activities.  The terms of the lease-purchase stipulate a 19%rate of interest (33% effective rate of interest) over a one-year term at whichpoint, title to the BPZ-02 will transfer to the Company upon final payment ofthe lease.  The Company has accounted for the transaction as a capitallease in accordance to SFAS No. 13, “Accounting For Leases (As Amended)”under the criteria the barge will transfer title at the end of the lease periodand, as a result, depreciation will be calculated over the economic life of theasset.

 

Theproduction equipment used on board the FPSO was financed through a separatecapital lease that commenced when the Company began utilizing the productionequipment on board the FPSO in June 2008.  The lease terms arevariable and bears an interest rate of 18% based on our incremental borrowingrate for similar equipment.  In accordance with the terms of the lease, abargain purchase option exists at the end of the lease.  As a result,depreciation will be calculated over the economic life of the asset.  The Companyrecorded the capital lease at $2.4 million, which represents the lesser of thepresent value of the minimum lease payments or the fair market value of theasset at the inception of the lease.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

SeeNote 9 “Long-Term Debt and Capital Lease Obligations” for further discussion ofboth leases referred to above.

 

*GE Turbine Purchase Agreement**and Amendment*

 

OnSeptember 26, 2008, the Company, through its subsidiary, entered into a$51.5 million contract for purchase of equipment and services with GE PackagedPower, Inc. and GE International, Inc. Sucursal de Peru, which arepart of GE Energy’s aeroderivative business.  Subsequent to December 31,2008, the Company and GE entered into an amendment of the contract. For furtherinformation regarding the original and amended contract see Note 1, “Basis ofPresentation and Significant Accounting Policies — Gas-to Power” for furtherinformation.

 

*Reserve-BasedCredit Facility*

 

InAugust 2008, the Company signed a Mandate Letter and Facility Term Sheetwith Natixis, a major French bank, to underwrite and structure, on an exclusivebasis, a $200.0 million reserve-based credit facility. The $200.0 millionreserve-based credit facility was approved by the Natixis Credit Committee in September 2008. Subsequent to December 31, 2008 the Company finalized a revised MandateLetter and Facility Term Sheet with Natixis. Based on current credit andcommodity market conditions, Natixis has now resized the facility toapproximately $90.0 million including the $15.0 million received under the$15.0 million Senior Note. See Note 9 “Long-Term Debt and Capital LeaseObligations” for further information. Once the facility is closed, theCompany expects the initial available borrowing capacity to be approximately$60.0 million, inclusive of the $15 million already closed and funded by IFC asdescribed in Note 9, “Long-Term Debt and Capital Lease Obligations -*$15.0 Million IFCReserve-Based Credit Facility*” above”. The existing Natixis credit committee approval remains in effect andboth the Natixis and IFC facilities will be governed by a Common TermsAgreement (“CTA”). Terms of the resized facility are expected to be alignedwith recent transactions in the market.

 

The Company expects to complete this financing inthe first part of the second quarter of 2009. However, the closing of thecredit facility is dependent upon the successful syndication of approximately50% of the facility and successful negotiation of the related loan documentsand funding is predicated on the satisfaction of certain conditions precedentas specified in the loan documents.

 

*Gas-to-PowerProject Financing*

 

On November 29, 2006, a $120.0 millionfinancing package was approved by the Credit Committee of the IFC for thedevelopment of the Company’s gas-to-power project.  Originally, IFCintended to loan $50.0 million, of which $19.5 million was invested in theCompany’s common stock in December 2006, with the remaining $70.0 millionto be syndicated to other financial institutions.

 

However, the discovery of oil in the Corvina field in early 2007resulted in the gas-to-power project being deferred and the Company’s decisionto focus on accelerating oil production.  As a result, the $30.5 millionbalance of the IFC commitment was transferred to the oil development projectand funded as follows:  $15.5 million of convertible debt funded inNovember, 2007 and converted into common stock in May, 2008 and $15.0 millionwas funded in October, 2008 with the reserve based facility. See “Note 9, “Long-Term Debt and CapitalLease Obligations” for further information on $15.0 millioncredit facility.

 

The Company currently estimates thegas-to-power project will cost approximately $130.0 million.  The IFC hasadvised it that approximately 65% of the project’s costs can be expected to befinanced with traditional project financing, given current marketconditions.  Accordingly, the Company has commenced discussions withpotential joint venture partners for the gas-to-power project in an attempt tosecure additional equity for the project.  Following the identificationand selection of a partner and consummation of project contracts, the Companywill enter into negotiations with the IFC regarding restructuring thegas-to-power financing. The Company is expecting terms to include an eight yearamortization of principal with interest rates to reflect the current marketconditions at the time of closing along with typical covenants for this type offinancing.  The closing of this financing, which is targeted for late 2009,will be subject to the satisfactory negotiation of loan and security documents.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Note 16 — LegalProceedings**

** **

*Navy TankerLitigation*

 

On October 24,2007, Tecnomarine, the Company’s former primary marine transportationcontractor, entered into two short term agreements with the commercial divisionof the Peruvian Navy to charter two small tankers for use in the Company’s offshoreoil production operation.  On January 30, 2008, one of thetankers, the Supe, sank after catching fire. Although neither of thegovernmental agencies charged with investigating the incident found fault withthe Company or the Company’s marine contractor, a lawsuit was filed against theCompany in Houston, Texas by two crewmembers and the family and estate of twoof the deceased sailors injured in the incident claiming negligence and grossnegligence on the part of the Company.  As none of the Peruvian governmentsanctioned investigations into the Supe incident found fault on the part ofTecnomarine, the Company or the Company’s subsidiary, BPZ Exploración andProducción S.R.L., the Company does not currently believe, based upon the knownfacts relating to the incident, that the outcome of the legal proceeding willhave a material adverse effect on its financial condition, results ofoperations or cash flows. Additionally, the Company believes the incident wouldbe covered by its insurance policies, after a customary deductible.

 

*Claim by FormerEmployee of Breach of Contract*

 

In the fourthquarter of 2008, a former employee of the Company filed a lawsuit against thecompany claiming a breach of contract under the terms of the Company’s LongTerm Incentive Compensation Plan.  Based upon the known facts relating tothe legal proceeding, the Company does not believe that the outcome of thelegal proceeding will have a material adverse effect on its financialcondition, results of operations or cash flows.

 

**Note 17 — Leaseand Purchase Obligations**

** **

The Company leases office space in Houston,Texas under an operating lease that expires in 2016. The Company also leasesfive offices and a warehouse in Lima, Peru under an operating lease expiring in2013. Additionally, the Company leases an administrative office Quito, Ecuadorunder a month-to-month lease. Total rent expense incurred for the years ended December 31,2008, 2007 and 2006 was approximately $0.5 million, $0.3million and $0.3million, respectively.

 

Minimum non-cancelable lease and purchasecommitments are as follows:

 

For Year Ending December 31,

 
| 2009                                          |   | $          | 7,889,990  |   |
|-----------------------------------------------|--------|------------|------------|--------|
| 2010                                          |   | 36,905,585 |       |
| 2011                                          |   | 977,148    |       |
| 2012                                          |   | 1,015,215  |       |
| 2013                                          |   | 1,054,759  |       |
| Thereafter                                    |   | 900,123    |       |
| Total minimum lease and purchase  commitments |   | $          | 48,742,820 |   |

 

Includesoperating leases for our executive office in Houston, Texas, and our branchoffices in Lima, Peru. In 2008, both our Houston office and Lima officesentered into agreements for additional office space of 7,070 square feet and22,500 square feet expiring 2016 and 2013, respectively.

 

Includesremaining amounts due to the purchase of three LM6000 gas-fired turbines fromGE for $51.5 million.  Due to theamendment, the lease payments include the required payments due in 2009 and theremaining balance under the original lease agreement in 2010.  However, both GE and BPZ have agreed todetermine new delivery dates, pricing and payment terms when the Companydecides to bring the lease-purchase out of the suspension period.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Note 18 —Subsequent Events**

** **

Subsequent to December 31,2008, the Company borrowed $1,000,000 from an individual described in Note 9 “Long-TermDebt and Capital Lease Obligations — Note Payable”.

 

Subsequent to December 31,2008, the Company entered into an amendment of its Agreement for the purchaseof three LM6000 gas-fired turbine turbines with GE described in Note 1 “Basisof Presentation and Significant Accounting Policies — Gas-to-Power”.

 

Subsequent to December 31,2008, the Company entered into a long-term oil supply agreement with Petroperudescribed in Note 12 “Revenue”.

 

Subsequent to December 31,2008, the Company closed a private placement to sell stock to certaininstitutional investors as described in Note 10 “Stockholders’ Equity”.

 

Subsequent to December 31,2008, the Company finalized a revised Mandate Letter and Facility Term Sheetwith Natixis as described in Note 15 “Commitments and Contingencies”.

 

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**BPZRESOURCES, INC AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Note 19 —Quarterly Results of Operations**

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **March 31,**               | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| **2008**                                           |       |                             |       |   |   |   |   |   |   |
| Revenue, net                                       |       | $                                | 4,367,262  |   | $ | 7,035,454 |   | $ | 33,440,330 |   | $ | 18,111,855 |   |
| Operating loss                                     |       | (7,539,040                       | )          | (5,225,413 | ) | 13,567,190 |   | (8,446,794 | ) |
| Other income (expense)                             |       | 209,247                          |       | 717,448 |   | 94,963 |   | 117,762 |   |
| Net loss                                           |       | $                                | (7,422,194 | ) | $ | (4,656,144 | ) | $ | 8,611,332 |   | $ | (6,179,482 | ) |
|                                               |       |                             |       |   |   |   |   |   |   |
| Basic net income (loss) per share                  |       | $                                | (0.10      | ) | $ | (0.06 | ) | $ | 0.11 |   | $ | (0.08 | ) |
| Diluted net income (loss) per share                |       | $                                | (0.10      | ) | $ | (0.06 | ) | $ | 0.11 |   | $ | (0.08 | ) |
|                                               |       |                             |       |   |   |   |   |   |   |
| Basic weighted average common share  outstanding   |       | 74,525,279                       |       | 77,680,924 |   | 78,574,955 |   | 78,748,390 |   |
| Diluted weighted average common share  outstanding |       | 74,525,279                       |       | 77,680,924 |   | 80,323,207 |   | 78,748,390 |   |
|                                               |       |                             |       |   |   |   |   |   |   |
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
| ** **                                         | ** ** | **March 31,**               | ** ** | **June 30,** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| **2007**                                           |       |                             |       |   |   |   |   |   |   |
| Revenue, net                                       |       | $                                | —     |   | $ | — |   | $ | — |   | $ | 2,350,388 |   |
| Operating loss                                     |       | (3,251,880                       | )          | (5,687,688 | ) | (7,586,791 | ) | (5,264,463 | ) |
| Other income (expense)                             |       | 52,862                           |       | 248,685 |   | 416,270 |   | 602,023 |   |
| Net loss                                           |       | $                                | (3,205,392 | ) | $ | (5,482,931 | ) | $ | (7,159,220 | ) | $ | (4,662,440 | ) |
| Basic and diluted net loss per share               |       | $                                | (0.05      | ) | $ | (0.08 | ) | $ | (0.10 | ) | $ | (0.06 | ) |
| Weighted average common share outstanding          |       | 63,309,294                       |       | 67,685,317 |   | 72,222,433 |   | 73,265,471 |   |

 

As restated for retroactive stock dividend, see Note 10, “Stockholders’Equity —*Merger Earn-out Shares — Stock Dividend*”above for additional information.

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL ANDGAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

**Supplemental Oil and Gas Disclosures (Unaudited)**

 

**Oil and Natural Gas Producing Activities**

 

The following disclosures for the Company aremade in accordance with SFAS No. 69, “Disclosures About Oil and NaturalGas Producing Activities (an amendment of FASB Statements 19, 25, 33 and 39)”.Users of this information should be aware that the process of estimating quantitiesof proved, proved developed and proved undeveloped crude oil and natural gasreserves is very complex, requiring significant subjective decisions in theevaluation of all available geological, engineering and economic data for eachreservoir. The data for a given reservoir may also change substantially overtime as a result of numerous factors including, but not limited to, additionaldevelopment activity, evolving production history and continual reassessment ofthe viability of production under varying economic conditions. Consequently,material revisions to existing reserve estimates occur from time to time.Although every reasonable effort is made to ensure that reserve estimatesreported represent the most accurate assessments possible, the significance ofthe subjective decisions required and variances in available data for variousreservoirs make these estimates generally less precise than other estimatespresented in connection with financial statement disclosures.

 

Proved reserves represent estimatedquantities of natural gas and crude oil that geological and engineering datademonstrate, with reasonable certainty, to be recoverable in future years fromknown reservoirs under economic and operating conditions existing at the timethe estimates were made.

 

Proved developed reserves are proved reservesexpected to be recovered, through wells and equipment in place and underoperating methods being utilized at the time the estimates were made.

 

Proved undeveloped reserves are reserves thatare expected to be recovered from new wells on undrilled acreage or fromexisting wells where a relatively major expenditure is required forrecompletion. Reserves on undrilled acreage are limited to those drilling unitsoffsetting productive units that are reasonably certain of production whendrilled. Proved reserves for other undrilled units can be claimed only where itcan be demonstrated with certainty that there is continuity of production fromthe existing productive formation. Estimates for proved undeveloped reservesare not attributed to any acreage for which an application of fluid injectionor other improved recovery technique is contemplated, unless such techniqueshave been proved effective by actual tests in the area and in the samereservoir.

 

Our relevant management controls over provedreserve attribution, estimation and evaluation include:

 

·                  controls overand processes for the collection and processing of all pertinent operating dataand documents needed by our independent reservoir engineers to estimate ourproved reserves;

 

·                  engagement ofwell qualified and independent reservoir engineers for review of our operatingdata and documents and preparation of reserve reports annually in accordancewith all SEC reserve estimation guidelines; and

 

·                  review by oursenior reservoir engineer and his staff of the independent reservoir engineers’reserves reports for completion and accuracy.

 

Market prices as of each year-end will beused for future sales of natural gas, crude oil and natural gas liquids. Futureoperating costs, production taxes and capital costs will be based on currentcosts as of each year-end, with no escalation. There are numerous uncertaintiesinherent in estimating quantities of proved reserves and in projecting thefuture rates of production and timing of development expenditures. Reserve datarepresent estimates only and should not be construed as being exact. Moreover,the standardized measure should not be construed as the current market value ofthe proved oil and natural gas reserves or the costs that would be incurred toobtain equivalent reserves. A market value determination would include manyadditional factors including (a) anticipated future changes in natural gasand crude oil prices, production and development costs, (b) an allowancefor return on investment, (c) the value of additional reserves, notconsidered proved at present, which may be recovered as a result of furtherexploration and development activities, and (d) other business risk.

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

***Capitalized Costs Relating to Oiland Gas Producing Activities***

 

The following table sets forth thecapitalized costs relating to the Company’s natural gas and crude oil producingactivities at December 31, 2008 and 2007:

 
| ** **                                                                                                          | ** ** | **2008**    | ** **  | **2007**   | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|-------------|-------------|------------|------------|
|                                                                                                                |       |        |        |       |       |
| Proved properties                                                                                                   |       | $           | 154,826,919 |       | $          | 73,447,919 |   |
| Unproved properties                                                                                                 |       | 15,343,284  |        | 23,780,837 |       |
| Total                                                                                                               |       | 170,170,203 |        | 97,228,756 |       |
| Less: Accumulated depreciation, depletion  and amorization                                                          |       | (15,946,183 | )           | (764,724   | )          |
| Net capitalized cost                                                                                                |       | 154,224,020 |        | 96,464,032 |       |
|                                                                                                                |       |        |        |       |       |
| Company’s share of cost method investees’  costs of property acquisition, exploration and development (1) |       | $           | —      |       | $          | — |   |

 

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(1)    BPZEnergy purchased the Investment in Ecuador Property in 2004.

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

Pursuantto SFAS No. 143 “Accounting for Asset Retirement Obligations”, netcapitalized cost includes asset retirement cost of $0.6 million and $0.3million as of December 31, 2008 and December 31, 2007, respectively.

 

***Costs Incurred in Oil and NaturalGas Property Acquisition, Exploration and Development Activities***

 

The following table sets forth costs incurredrelated to the Company’s oil and natural gas activities for the year ended December 31,2008 and 2007:

 
| ** **                                                                                                          | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| **Year Ended December 31, 2008:**                                                                              |       |       |       |
| Acquisition costs of properties                                                                                     |       |       |       |
| Proved                                                                                                              |       | $          | —     |   |
| Unproved                                                                                                            |       | —     |       |
|                                                                                                                |       |       |       |
| Subtotal                                                                                                            |       | —     |       |
| Exploration costs                                                                                                   |       | 794,925    |       |
| Development costs                                                                                                   |       | 82,844,977 |       |
|                                                                                                                |       |       |       |
| Total                                                                                                               |       | $          | 83,639,902 |   |
|                                                                                                                |       |       |       |
| Company’s share of cost method investees’  costs of property acquisition, exploration and development (1) |       | $          | —     |   |
|                                                                                                                |       |       |       |
| **Year Ended December 31, 2007:**                                                                              |       |       |       |
| Acquisition costs of properties                                                                                     |       |       |       |
| Proved                                                                                                              |       | $          | —     |   |
| Unproved                                                                                                            |       | 10,964     |       |
|                                                                                                                |       |       |       |
| Subtotal                                                                                                            |       | 10,964     |       |
| Exploration costs                                                                                                   |       | 19,122,831 |       |
| Development costs                                                                                                   |       | 47,733,574 |       |
|                                                                                                                |       |       |       |
| Total                                                                                                               |       | $          | 66,867,369 |   |
|                                                                                                                |       |       |       |
| Company’s share of cost method investees’  costs of property acquisition, exploration and development (1) |       | $          | —     |   |

 

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(1)    BPZEnergy purchased the Investment in Ecuador Property in 2004.

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

***Results of Operations for Oil andNatural Gas Producing Activities***

 

The results of operations for oil and naturalgas producing activities exclude interest charges and general andadministrative expenses. Sales are based on market prices.

 
| ** **                                                                                             | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
| Oil and natural gas production revenues                                                                |       |                                       |       |   |   |   |   |
| Third-party                                                                                            |       | $                                          | 62,954,901 |   | $ | 2,350,388 |   | $ | — |   |
| Affiliate                                                                                              |       | —                                     |       | — |   | — |   |
|                                                                                                   |       |                                       |       |   |   |   |   |
| Total revenues                                                                                         |       | 62,954,901                                 |       | 2,350,388 |   | — |   |
| Exploration expenses                                                                                   |       | 794,925                                    |       | 4,045,381 |   | 2,048,742 |   |
| Production costs                                                                                       |       | 11,648,877                                 |       | 754,833 |   | — |   |
| Depreciation, depletion and amortization                                                               |       | 15,141,181                                 |       | 537,892 |   | — |   |
| Oil and natural gas impairment                                                                         |       | —                                     |       | — |   | — |   |
|                                                                                                   |       |                                       |       |   |   |   |   |
| Income (loss) before income taxes                                                                      |       | 35,369,918                                 |       | (2,987,718 | ) | (2,048,742 | ) |
| Income tax provision (benefit)                                                                         |       | 3,141,851                                  |       | — |   | — |   |
|                                                                                                   |       |                                       |       |   |   |   |   |
| Results of continuing operations                                                                       |       | $                                          | 32,228,067 |   | $ | (2,987,718 | ) | $ | (2,048,742 | ) |
|                                                                                                   |       |                                       |       |   |   |   |   |
| Company’s share of cost method investees’  results of operations for producing activities(1) |       | $                                          | 905,155    |   | $ | 451,615 |   | $ | 1,590,882 |   |

 

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(1)    Investmentin Ecuador Property

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

***Net Proved and Proved DevelopedReserve Summary***

 

The following table setsforth the Company’s net proved and proved developed reserves at December 31,2008, 2007 and 2006, and the changes in the net proved reserves for each of thethree years in the period then ended.

 
| ** **                                                                                                                           | ** ** | **Natural gas  (Mcf)(1)(7)** | ** ** | **Natural gas liquids  and crude oil  (Bbl)(2)(3)** | ** ** | **(Bbl)(2)  equivalents(4)** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|-------------------------------------------------------------------------|------------|------------------------------|------------|
|                                                                                                                                 |       |                              |       |                                                                    |       |                         |       |
| Net proved reserves at December 31,  2006                                                                                       |       | —                            |       | —                                                                  |       | —                       |       |
|                                                                                                                                 |       |                              |       |                                                                    |       |                         |       |
| Revisions of previous estimates                                                                                                      |       | —                            |       | —                                                                  |       | —                       |       |
| Purchases in place                                                                                                                   |       | —                            |       | —                                                                  |       | —                       |       |
| Extensions, discoveries and other additions                                                                                          |       | —                            |       | 11,980,822                                                              |       | 11,980,822                   |       |
| Sales in place                                                                                                                       |       | —                            |       | —                                                                  |       | —                       |       |
| Production                                                                                                                           |       | —                            |       | (41,090                                                                 | )          | (41,090                      | )          |
| Other                                                                                                                                |       | —                            |       | —                                                                  |       | —                       |       |
|                                                                                                                                 |       |                              |       |                                                                    |       |                         |       |
| Net proved reserves at December 31,  2007                                                                                       |       | —                            |       | 11,939,732                                                              |       | 11,939,732                   |       |
|                                                                                                                                 |       |                              |       |                                                                    |       |                         |       |
| Revisions of previous estimates                                                                                                      |       | —                            |       | (1,699,481                                                              | )          | (1,699,481                   | )          |
| Purchases in place                                                                                                                   |       | —                            |       | —                                                                  |       | —                       |       |
| Extensions, discoveries and other additions                                                                                          |       | —                            |       | 7,740,086                                                               |       | 7,740,086                    |       |
| Sales in place                                                                                                                       |       | —                            |       | —                                                                  |       | —                       |       |
| Production                                                                                                                           |       | —                            |       | (826,534                                                                | )          | (826,534                     | )          |
| Other                                                                                                                                |       | —                            |       | —                                                                  |       | —                       |       |
|                                                                                                                                 |       |                              |       |                                                                    |       |                         |       |
| Net proved reserves at December 31,  2008                                                                                       |       | —                            |       | 17,153,803                                                              |       | 17,153,803                   |       |
|                                                                                                                                 |       |                              |       |                                                                    |       |                         |       |
| Company’s proportional interest in reserves  of investees accounted for by the cost method—December 31, 2008 (6) |       | —                            |       | 198,398                                                                 |       | 198,398                      |       |

 

***Net Proved Developed ReservesSummary***

 
| ** **                 | ** ** | **Natural gas  (Bcf) (7)** | ** ** | **Natural gas liquids  and crude oil (Bbl)** | ** ** | **Bcf equivalents  (5)** | ** ** |
|----------------------------|------------|--------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------|------------|
|                       |       |                                 |       |                                                                  |       |                          |       |
| December 31, 2006 (8) |       | —                               |       | —                                                                |       | —                        |       |
|                       |       |                                 |       |                                                                  |       |                          |       |
| December 31, 2007     |       | —                               |       | 2,976,868                                                             |       | 17.9                          |       |
|                       |       |                                 |       |                                                                  |       |                          |       |
| December 31, 2008     |       | —                               |       | 4,223,398                                                             |       | 25.3                          |       |

 

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(1)          Thousands of cubic feet.

(2)          Barrels.

(3)          Includes crude oil,condensate and natural gas liquids.

(4)          Naturalgas volumes have been converted to equivalent natural gas liquids and crude oilvolumes using a conversion factor of six thousand cubic feet of natural gas toone barrel of natural gas liquids and crude oil.

(5)          Billioncubic feet or billion cubic feet equivalent, as applicable

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

(6)          Basedon a rollforward of the independent reservoir engineer’s report provided by theoperator of the Santa Elena property.

(7)          Wedo not currently have the financial capacity or commitments for a developmentprogram of this magnitude for our gas reserves. Accordingly, the Company hasnot disclosed amounts of proved gas reserves in its SEC filings. At such timeas we obtain sufficient financial commitments to proceed with the fulldevelopment of the gas to power project and all other conditions necessary torecord proved reserves are met, we expect to record SEC proved gas reserves aspermitted under SEC rules and disclose such reserves in future SECfilings.

(8)          Wedid not have the financial capacity or commitments for a development program ofthis magnitude. Accordingly, the Company did not disclose amounts of provedreserves in its SEC filings for the year ended December 31, 2006.

 

***Standardized Measure ofDiscounted Future Net Cash Flows Relating to Proved Oil and Natural GasReserves***

 

The following informationhas been developed utilizing procedures prescribed by SFAS No. 69 andbased on natural gas and crude oil reserve and production volumes estimated bythe independent petroleum reservoir engineers. This information may be usefulfor certain comparison purposes but should not be solely relied upon inevaluating the Company or its performance. Further, information contained inthe following table should not be considered as representative of realisticassessments of future cash flows, nor should the standardized measure ofdiscounted future net cash flows be viewed as representative of the currentvalue of the Company’s oil and natural gas assets.

 

The future cash flowspresented below are based on sales prices, cost rates and statutory income taxrates in existence as of the date of the projections. It is expected thatmaterial revisions to some estimates of natural gas and crude oil reserves mayoccur in the future, development and production of the reserves may occur inperiods other than those assumed, and actual prices realized and costs incurredmay vary significantly from those used. Income tax expense has been computedusing expected future tax rates and giving effect to tax deductions and creditsavailable, under current laws, and which relate to oil and natural gasproducing activities.

 

Management does not relyupon the following information in making investment and operating decisions.Such decisions are based upon a wide range of factors, including estimates ofprobable as well as proved reserves and varying price and cost assumptions consideredmore representative of a range of possible economic conditions that may beanticipated.

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

The following table setsforth the standardized measure of discounted future net cash flows fromprojected production of the Company’s natural gas and crude oil reserves forthe years ended December 31, 2008, 2007 and 2006:

 
| **December 31, 2008**                                                                                                            |   |         |          |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|--------------|---------------|
| Future cash inflows                                                                                                                   |   | $            | 648,413,900   |   |
| Future production costs                                                                                                               |   | (103,999,100 | )             |
| Future development costs                                                                                                              |   | (127,300,000 | )             |
| Future income tax expenses                                                                                                            |   | (62,240,029  | )             |
| Future net cash flows                                                                                                                 |   | 354,874,771  |          |
| Discount to present value at 10% annual  rate                                                                                         |   | (55,947,837  | )             |
| Standardized measure of discounted future  net cash flows relating to proved natural gas, natural gas liquids and crude  oil reserves |   | $            | 298,926,934   |   |
|                                                                                                                                  |   |         |          |
| Company’s share of cost method investees’  standardized measure of discounted future net cash flows (1)(2)                  |   | $            | 2,755,897     |   |
|                                                                                                                                  |   |         |          |
| **December 31, 2007**                                                                                                            |   |         |          |
| Future cash inflows                                                                                                                   |   | $            | 1,020,728,000 |   |
| Future production costs                                                                                                               |   | (135,262,500 | )             |
| Future development costs                                                                                                              |   | (79,400,000  | )             |
| Future income tax expenses                                                                                                            |   | (155,081,716 | )             |
| Future net cash flows                                                                                                                 |   | 650,983,784  |          |
| Discount to present value at 10% annual  rate                                                                                         |   | (94,301,509  | )             |
|                                                                                                                                  |   |         |          |
| Standardized measure of discounted future  net cash flows relating to proved natural gas, natural gas liquids and crude  oil reserves |   | $            | 556,682,275   |   |
|                                                                                                                                  |   |         |          |
| Company’s share of cost method investees’  standardized measure of discounted future net cash flows (1)(2)                  |   | $            | 3,400,241     |   |
|                                                                                                                                  |   |         |          |
| **December 31, 2006**                                                                                                            |   |         |          |
| Future cash inflows                                                                                                                   |   | $            | —        |   |
| Future production costs                                                                                                               |   | —       |          |
| Future development costs                                                                                                              |   | —       |          |
| Future income tax expenses                                                                                                            |   | —       |          |
| Future net cash flows                                                                                                                 |   | —       |          |
| Discount to present value at 10% annual  rate                                                                                         |   | —       |          |
|                                                                                                                                  |   |         |          |
| Standardized measure of discounted future  net cash flows relating to proved natural gas, natural gas liquids and crude  oil reserves |   | $            | —        |   |
|                                                                                                                                  |   |         |          |
| Company’s share of cost method investees’  standardized measure of discounted future net cash flows (1)(2)                  |   | $            | 4,191,079     |   |

 

----

(1)          Investment in EcuadorProperty

(2)          Based on a rollforwardof the independent reservoir engineer’s report provided by the operator of theSanta Elena property.

 

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**BPZ RESOURCES, INC AND SUBSIDIARIES****SUPPLEMENTAL DISCLOSURES ABOUT OIL AND GAS PRODUCING ACTIVITIES**

 

**YEARSENDED DECEMBER 31, 2008, 2007 and 2006**

 

The following table sets forth the principalchanges in the aggregate standardized measure of discounted future net cashflows attributable to the Company’s proved crude oil reserves. As 2008 is thefirst subsequent year to the Company’s initial development and production ofits proved oil reserves, the required information is presented only forthe year ended December 31, 2008 as follows:

 
| Standardized measure of discounted future  net cash flows, December 31, 2007                        |   | $            | 556,682,275 |   |
|----------------------------------------------------------------------------------------------------------|--------|--------------|-------------|--------|
| Sales and transfers of natural gas, natural  gas liquids and crude oil produced, net of production costs |   | (51,306,024  | )           |
| Net changes in prices and production costs                                                               |   | (368,286,619 | )           |
| Extensions, discoveries, additions and  improved recovery, net of related costs                          |   | 160,830,600  |        |
| Development costs incurred                                                                               |   | 82,844,977   |        |
| Revisions of previous quantity estimates  and development costs                                          |   | (42,462,399  | )           |
| Accretion of discount                                                                                    |   | 30,501,206   |        |
| Net change in income taxes                                                                               |   | (64,329,634  | )           |
| Changes in timing and other                                                                              |   | (5,547,448   | )           |
| Standardized measure of discounted future  net cash flows, December 31, 2008                        |   | $            | 298,926,934 |   |

 

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**ITEM 9. CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES**

** **

None.

 

**ITEM 9A. CONTROLS ANDPROCEDURES**

** **

**(a)****          Evaluation of DisclosureControls and Procedures**

 

We performed an evaluation,under the supervision and with the participation of our management, includingour principal executive officer and principal financial officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report. Based on thatevaluation, our principal executive officer and principal financial officerhave concluded that as of December 31, 2008 our disclosure controls andprocedures, as defined in Rule 13a-15(e), are effective to ensure thatinformation we are required to disclose in the reports we file or submit underthe Securities Exchange Act of 1934 is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms. Our disclosure controls and proceduresinclude controls and procedures designed to ensure that information required tobe disclosed in reports filed or submitted under the Exchange Act is accumulatedand communicated to our management, including our principal executive officerand principal financial officer, as appropriate, to allow timely decisionsregarding required disclosures.

 

**(b)****         Changes in InternalControl Over Financial Reporting**

 

There was no change in theCompany’s internal control over financial reporting during the quarter ended December 31,2008 that has materially affected, or is reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

**(c)****         Management’s Report onInternal Control over Financial Reporting and Report of IndependentRegistered Public Accounting Firm on Internal Control over Financial Reporting**

 

Management of the Company, including ourprincipal executive officer and principal financial officer, is responsible forestablishing and maintaining adequate internal controls over financialreporting, as defined in Rule 13a-15(f) of the Securities Exchange Act of1934, as amended. Our internal controls are designed to provide reasonableassurance as to the reliability of our financial reporting and the preparationand presentation of the consolidated financial statements for external purposesin accordance with accounting principles generally accepted in the UnitedStates, as well as to safeguard assets from unauthorized use or disposition.

 

Management conducted an evaluation of theeffectiveness of our internal controls over financial reporting based on theframework in *Internal Control — Integrated Framework*issued by the Committee of Sponsoring Organizations of the TreadwayCommission. This evaluation included review of the documentation of controls,evaluation of the design effectiveness of controls, testing of the operatingeffectiveness of controls and a conclusion on this evaluation. We did notidentify any material weaknesses in our internal controls as a result of thisevaluation. Based on this evaluation, management has concluded that ourinternal controls over financial reporting were effective as of December 31,2008.

 

Johnson Miller & Co., CPA’s PC, theindependent registered public accounting firm who also audited our consolidatedfinancial statements, has issued an attestation report on our internal controlover financial reporting as of December 31, 2008, which is set forth belowunder “Attestation Report”.

 

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**(d)****          Attestation Report**

 

Report of IndependentRegistered Public Accounting Firm

on Internal Control overFinancial Reporting

 

To the Board of Directors and Shareholders BPZ Resources, Inc. and Subsidiaries

Houston, Texas

 

We have audited BPZ Resources, Inc. and Subsidiaries’ internalcontrol over financial reporting as of December 31, 2008, based oncriteria established in *Internal Control —Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (the COSO criteria). BPZ Resources, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting, included in the accompanying Item 9A, “Management’s Annual Report on Internal Control Over Financial Reporting”. Our responsibilityis to express an opinion on the Company’s internal control over financialreporting based on our audit.

 

We conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, assessing the risk that a material weaknessexists, and testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk. Our audit also included performingsuch other procedures as we considered necessary in the circumstances. Webelieve that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles. A company’s internalcontrol over financial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

In our opinion, BPZ Resources, Inc. maintained, in all materialrespects, effective internal control over financial reporting as of December 31,2008, based on the COSO criteria*.*

 

We also have audited, in accordance with the standards of the PublicCompany Accounting Oversight Board (United States), the consolidated balancesheets of BPZ Resources, Inc. and Subsidiaries as of December 31,2008 and 2007, and the related consolidated statements of operations,stockholders’ equity (deficit), and cash flows for each of the three years inthe period ended December 31, 2008 and our report dated February 27,2009 expressed an unqualified opinion thereon.

 

Johnson Miller & Co., CPA’s PC Midland, Texas February 27, 2009

 

**ITEM 9B. OTHERINFORMATION**

 

None.

 

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**PART III**

** **

**ITEM 10. DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

** **

The information required by this item isincorporated by reference from our definitive proxy statement to be filed withthe SEC within 120 days after the end of our fiscal year covered by this AnnualReport on Form 10-K.

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

The information required bythis item is incorporated by reference from our definitive proxy statement tobe filed with the SEC within 120 days after the end of our fiscal year coveredby this Annual Report on Form 10-K.

 

**ITEM 12. SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

** **

The information required bythis item is incorporated by reference from our definitive proxy statement tobe filed with the SEC within 120 days after the end of our fiscal year coveredby this Annual Report on Form 10-K.

 

**ITEM 13. CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE**

** **

**Theinformation required by this item is incorporated by reference from ourdefinitive proxy statement to be filed with the SEC within 120 days after theend of our fiscal year covered by this Annual Report on Form 10-K.**

** **

**ITEM 14. PRINCIPALACCOUNTANT FEES AND SERVICES**

** **

Theinformation required by this item is incorporated by reference from ourdefinitive proxy statement to be filed with the SEC within 120 days after theend of our fiscal year covered by this Annual Report on Form 10-K.

 

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**PART IV**

 

**ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

 
| (a) The following  documents are filed as part of this report: | ** **                                                                                                                                                                                                                                                                                                                                                                                                                        |
|---------------------------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                          | ** **                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** |
| **1.**                                                              | **Financial Statements.**                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** |
| ** **                                                          | ** **                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** |
| ** **                                                          | **Our consolidated financial  statements are included in Part II, Item 8 of this report:**                                                                                                                                                                                                                                                                                                                                   | **53** |
| ** **                                                          | ** **                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** |
|                                                                | Report of Independent Registered Public Accounting  Firm                                                                                                                                                                                                                                                                                                                                                                          | 54 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Consolidated  Balance Sheets                                                                                                                                                                                                                                                                                                                                                                                                      | 55 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Consolidated  Statements of Operations                                                                                                                                                                                                                                                                                                                                                                                            | 56 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Consolidated Statements of Stockholders’ Equity  (Deficit)                                                                                                                                                                                                                                                                                                                                                                   | 57 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Consolidated  Statements of Cash Flows                                                                                                                                                                                                                                                                                                                                                                                            | 58 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Notes to the Consolidated Financial Statements                                                                                                                                                                                                                                                                                                                                                                                    | 59 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Supplemental  Oil and Gas Disclosures (Unaudited)                                                                                                                                                                                                                                                                                                                                                                                 | 88 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Management’s  Report on Internal Control Over Financial Reporting                                                                                                                                                                                                                                                                                                                                                            | 96 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
|                                                                | Report  of Independent Registered Public Accounting Firm on Internal Control over  Financial Reporting                                                                                                                                                                                                                                                                                                                            | 97 |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |   |
| **2.**                                                              | **Financial Statements Schedules  and supplementary information required to be submitted:**                                                                                                                                                                                                                                                                                                                                       |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                                                                | None.                                                                                                                                                                                                                                                                                                                                                                                                                             |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| **3.**                                                              | **Exhibits**                                                                                                                                                                                                                                                                                                                                                                                                                      |
|                                                                |                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                                                                | A list of the exhibits  filed or furnished with this report on Form 10-K (or incorporated by  reference to exhibits previously filed or furnished by us) is provided in the  Exhibit Index beginning on page 103 of this report. Those exhibits  incorporated by reference herein are indicated as such by the information  supplied in the parenthetical thereafter. Otherwise, the exhibits are filed  herewith. |

 

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**GLOSSARY OF OIL AND NATURAL GAS TERMS**

 

The following areabbreviations and definitions of terms commonly used in the oil and natural gasindustry that are used in this report.

 

*Bbl*. One stocktank barrel or 42 U.S. gallons liquid volume.

 

*Bcf*. Billion cubic feet of natural gas.

 

*Bcfe*. Billion cubic feet equivalent determinedusing the ratio of approximately six Mcf of natural gas to one Bbl of crudeoil, condensate or natural gas liquids.

 

*Bopd*. Barrels ofoil per day.

 

*Development well*. A welldrilled within the proved area of an oil or natural gas reservoir to the depthof a stratigraphic horizon known to be productive.

 

*Drill Stem Test*. A test of theflow rates of a formation thru the drill pipe to determine the fluid and gascontent, pressure and estimated production rates of the reservoir.

 

*Dry hole or well*. A well foundto be incapable of producing hydrocarbons in sufficient quantities such thatproceeds from the sale of such production would exceed production expenses andtaxes.

 

*Exploitation*. A drilling orother project which may target proven or unproven reserves (such as probable orpossible reserves), but which generally has a lower risk than that associatedwith exploration projects.

 

*Exploratory well*. A welldrilled to find and produce oil or natural gas reserves not classified asproved, to find a new reservoir in a field previously found to be productive ofoil or natural gas in another reservoir or to extend a known reservoir.

 

*Field*. An areaconsisting of a single reservoir or multiple reservoirs all grouped on orrelated to the same individual geological structural feature and/orstratigraphic condition.

 

*Gross acres or gross wells*. The totalacres or wells, as the case may be, in which a working interest is owned.

 

*MBbls*. One thousandbarrels of crude oil or other liquid hydrocarbons.

 

*Mcf*. One thousandcubic feet.

 

*Mcfe*. One thousandcubic feet equivalent, determined using the ratio of approximately six Mcf ofnatural gas to one Bbl of crude oil or other hydrocarbon.

 

*MMBbls*. One millionbarrels of crude oil or other liquid hydrocarbons.

 

*MMBtu*. One millionBritish thermal units.

 

*MMcf*. One millioncubic feet.

 

*MMcfe*. One millioncubic feet equivalent, determined using a ratio of six Mcf of natural gas toone Bbl of crude oil condensate or natural gas liquids.

 

*Net acres or net wells*. The sum ofthe fractional working interests owned in gross acres or gross wells, as thecase may be.

 

*Oil*. Crude oil,condensate and natural gas liquids.

 

*Productive well*. A well thatis found to be capable of producing hydrocarbons.

 

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*Proved developed reserves*. Reserves thatcan be expected to be recovered through existing wells with existing equipmentand operating methods. Additional oil and gas expected to be obtained throughthe application of fluid injection or other improved recovery techniques forsupplementing the natural forces and mechanisms of primary recovery areincluded in “proved developed reserves” only after testing by a pilot projector after the operation of an installed program has confirmed through productionresponse that increased recovery will be achieved. The SEC provides a completedefinition of proved developed reserves in Rule 4-10(a)(3) ofRegulation S-X.

 

*Proved reserves*. Proved oiland gas reserves are the estimated quantities of crude oil, natural gas andnatural gas liquids which geological and engineering data demonstrates withreasonable certainty to be recoverable in future years from known reservoirsunder existing economic and operating conditions, i.e., prices and cost as ofthe date the estimate is made. Prices include consideration of changes inexisting prices provided only by contractual arrangements, but not onescalations based on future conditions. The SEC provides a complete definitionof proved reserves in Rule 4-10(a)(2) of Regulation S-X.

 

*Proved undeveloped reserves*. Proved oiland gas reserves that are expected to be recovered from new wells on undrilledacreage or from existing wells where a relatively major expenditure is requiredfor recompletion. Reserves on undrilled acreage shall be limited to thosedrilling units offsetting productive units that are reasonably certain ofproduction when drilled. Proved reserves for other undrilled units can beclaimed only where it can be demonstrated with certainty that there iscontinuity of production from the existing productive formation. Under nocircumstances should estimates for proved undeveloped reserves be attributableto any acreage for which an application of fluid injection or other improvedrecovery technique is contemplated, unless such techniques have been provedeffective by actual tests in the area and in the same reservoir. The SEC providesa complete definition of proved undeveloped reserves in Rule 4-10(a)(4) ofRegulation S-X.

 

*PV-10 value*. The presentvalue of estimated future net revenues to be generated from the production ofproved reserves, determined in accordance with the rules and regulationsof the SEC (using prices and costs in effect as of the date of estimation)without giving effect to non-property related expenses such as general andadministrative expenses, debt service and future income tax expenses or todepreciation, depletion and amortization and discounted using an annualdiscount rate of 10%.

 

*Recompletion*. Thecompletion for production of an existing well bore in another formation fromthat which the well has been previously completed.

 

*Reservoir*. A porous andpermeable underground formation containing a natural accumulation of producibleoil and/or natural gas that is confined by impermeable rock or water barriersand is individual and separate from other reserves.

 

*Workover*. A remedialoperation on a completed well to restore, maintain or improve the well’sproduction.

** **

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** **

**SIGNATURES**

** **

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized, on March 2, 2009.

 
|        |   | BPZ  Resources, Inc. |                                              |
|--------|--------|---------------------------|---------------------------------------------------|
|   |   |                      |                                              |   |
|   |   | By:                       | */s/ Manuel Pablo Zúñiga-Pflücker* |
|   |   |                      | Manuel Pablo  Zúñiga-Pflücker      |   |
|   |   |                      | President &  Chief Executive Officer     |   |

 

Pursuant tothe requirements of the Securities Act of 1934, this report has been signedbelow by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

 
| /s/  MANUEL  PABLO ZÚÑIGA-PFLÜCKER |     | /s/  EDWARD  G. CAMINOS                      |
|-------------------------------------------------------------|----------|--------------------------------------------------------|
| Manuel  Pablo Zúñiga-Pflücker                |     | Edward  G. Caminos                                     |
| *President, Chief Executive Officer and Director*           | * * | *Chief Financial Officer*                              |
| March 2,  2009                                         | * * | *(Principal Financial Officer)*                        |
|                                                        |     | March 2,  2009                                    |
|                                                        |     |                                                   |
| /s/  HEATH  W. CLEAVER                            |     | /s/  DR.  FERNANDO ZÚÑIGA Y RIVERO |
| Heath  W. Cleaver                                           |     | Dr. Fernando  Zúñiga y Rivero           |
| *Vice President — Chief Accounting Officer*            | * * | *Director and Chairman of the Board*                   |
| *(Principal Accounting Officer)*                            |     | March 2,  2009                                    |
| March 2,  2009                                         |     |                                                   |
|                                                        |     |                                                   |
| /s/  E.  BARGER MILLER III                        |     | /s/  GORDON  GRAY                            |
| E.  Barger Miller III                                       |     | Gordon  Gray                                           |
| *Director*                                                  | * * | *Director*                                             |
| March 2,  2009                                         |     | March 2,  2009                                    |
|                                                        |     |                                                   |
| /s/  DENNIS  G. STRAUCH                           |     | /s/  JOHN  J. LENDRUM, III              |
| Dennis  G. Strauch                                          |     | John  J. Lendrum, III                             |
| *Director*                                                  | * * | *Director*                                             |
| March 2,  2009                                         |     | March 2,  2009                                    |

 

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**INDEX OF EXHIBITS**

** **
| 2.1    |   | Plan of Conversion for BPZ Energy, Inc. (incorporated by  reference to Exhibit 2.1 to the Company’s Form 8-K filed on  August 24, 2007).                                                                                                                       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                    |
| 3.1    |   | Certificate of Formation of BPZ Resources, Inc. (incorporated by  reference to Exhibit 3.1 to the Company’s Form 8-K filed on  August 24, 2007).                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                    |
| 3.2    |   | Bylaws of BPZ Resources, Inc. (incorporated by reference to  Exhibit 3.2 to the Company’s Form 8-K filed on August 17,  2007).                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                    |
| 4.1    |   | Form of Certificate for Common Stock of BPZ  Resources, Inc., a Texas corporation (incorporated by reference to  Exhibit 99.1 to the Company’s Form 10-Q filed on November 8,  2007).                                                                     |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.1*  |   | BPZ Energy, Inc. 2005 Long-Term Incentive Compensation Plan  (incorporated by reference to Exhibit 4.1 to the Company’s Form S-8  filed on July 5, 2005 (SEC File No. 333- 126388)).                                                                      |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.2*  |   | BPZ Energy, Inc. 2007 Long-Term Incentive Compensation Plan  (incorporated by reference to Exhibit 10.1 to the Company’s  Form 8-K filed on August 24, 2007).                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.3*  |   | BPZ Energy, Inc. 2007 Directors Compensation Incentive Plan  (incorporated by reference to Exhibit 10.2 to the Company’s  Form 8-K filed on August 24, 2007).                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.4   |   | Merger Agreement between Navidec, Inc. and BPZ Energy, Inc.  dated July 8, 2004 (incorporated by reference to Exhibit 10.1 from  the Company’s Form 8-K filed on July 13, 2004).                                                                     |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.5   |   | 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 on September 14, 2004).                                                                  |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.6   |   | 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 filed on February 14, 2005 (SEC File  No. 333-122816)).                                        |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.7   |   | 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 filed on April 15, 2005). |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.8   |   | 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 filed on February 14, 2005 (SEC File  No. 333-122816)).                                        |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.9   |   | License Contract from the Government of Peru for Block XXII dated  November 21, 2007 (incorporated by reference to Exhibit 10.9 to the  Company’s Form 10-K filed on March 14, 2008)                                                                           |
|   |   |                                                                                                                                                                                                                                                                                    |
| 10.1   |   | License Contract from the Government of Peru for Block XXIII dated  November 21, 2007 (incorporated by reference to Exhibit 10.10 to  the Company’s Form 10-K filed on March 14, 2008).                                                                        |

 

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Table of Contents

 
| 10.11  |   | Contract No. 001-2009-Mextipetroperu - Supply of 17,000,000  Barrels of Crude Oil for Talara Refinery dated January 8, 2009, by and  among BPZ Exploración & Producción S.R.L., and Petroleos del  Perú-PETROPERU S.A.(incorporated by reference to Exhibit 10.1 to the  Company’s Form 8-K filed on January 14, 2009).       |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.12  |   | Contract for Sale of Equipment and Services dated September 26,  2008 (incorporated by reference to Exhibit 10.11 to BPZ  Resources, Inc.’s Quarterly Report on Form 10-Q for the quarter  ended September 30, 2008 filed on November 10, 2008).                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.13  |   | Amendment dated January 23, 2009 to Contract for Sale of  Equipment and Services dated September 26, 2008 by and among GE Packaged  Power, Inc. GE International, Inc. Sucursal De Peru and Empresa  Eléctrica Nueva Esperanza, SRL (incorporated by reference to  Exhibit 10.2 to the Company’s Form 8-K filed on January 29,  2009). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.14  |   | C Loan Agreement between BPZ Resources, Inc. (formerly BPZ  Energy, Inc.) and International Finance Corporation, dated  November 17, 2007 (incorporated by reference to Exhibit 10.1 to the  Company’s Form 8-K filed on November 26, 2007).                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.15  |   | Loan Agreement between BPZ Exploracion & Produccion S.R.L  and BPZ Marine Peru S.R.L and International Finance Corporation dated as of  August 15, 2008.                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.16  |   | Common Terms Agreement between BPZ Exploracion & Produccion  S.R.L and BPZ Marine Peru S.R.L., as borrowers, and International Finance  Corporation,as lender, and the Additional Secured Facility Lenders dated as  of August 15, 2008.                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.17  |   | Stock Purchase Agreement by and among BPZ Resources, Inc. and  Investors (incorporated by reference to Exhibit 10.1 to the Company’s  Form 8-K filed on February 24, 2009).                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 14.1   |   | Code of Ethics for Executive Officers (incorporated by reference to  Exhibit 14.1 to Form 10-KSB/A filed on September 26, 2006).                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 21.1   |   | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 23.1   |   | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 23.2   |   | Consent of Independent Petroleum Engineers and Geologists.                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 31.1   |   | Certification of the Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 31.2   |   | Certification of the Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 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.                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                |
| 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.                                                                                                                                                                                                                   |

 

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* - Management Contract or Compensatory Plan or Arrangement.

 

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