**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

**FORM 10-Q**
| **(Mark One)**                                                      |
|---------------------------------------------------------------------|
| ** **                                                          |
| **x**                                                               | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|                                                                |
| **For the  quarterly period ended:   September 30, 2006** |
| ** **                                                          |
| **o**                                                               | **TRANSITION  REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
| ** **                                                          | ** ** |
| ** **                                                          | **For the  transition period  from         to** |

 

**Commission File Number: 000-29098**

**BPZ ENERGY, INC.**

(Exactname of registrant as specified in its charter)
| **Colorado**                                    | ** ** | **33-0502730**                           |
|-------------------------------------------------|------------|------------------------------------------|
| (State or other  jurisdiction of incorporation) |       | (I.R.S. Employer  Identification Number) |

 

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

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

Indicateby check mark whether the registrant (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 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 markwhether the registrant is a large accelerated filer, an accelerated file or anon-accelerated filer.  See definition of“accelerated filer” and “large accelerated filer” in Rule 12b-2 of the ExchangeAct.  (Check one):
| Large Accelerated Filer o | Accelerated Filer o | Non-Accelerated Filer x |
|---------------------------|---------------------|-------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes o  No x

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date:

As of November 7, 2006, there were 47,352,217 shares of common stock, no parvalue, outstanding.

 

----

**TABLE OF CONTENTS**
| **PART I**  | Page                                                                                        |
|------------------|---------------------------------------------------------------------------------------------|
|             |                                                                                        |   |
| Item 1.          | Financial Statements                                                                        | 3 |
|             |                                                                                        |   |
|             | Consolidated  Balance Sheets                                                                | 3 |
|             |                                                                                        |   |
|             | Consolidated  Statements of Operations                                                      | 4 |
|             |                                                                                        |   |
|             | Consolidated  Statement of Stockholders’ Equity                                        | 5 |
|             |                                                                                        |   |
|             | Consolidated  Statements of Cash Flows                                                      | 6 |
|             |                                                                                        |   |
|             | Notes  to Consolidated Financial Statements                                                 | 7 |
|             |                                                                                        |   |
| Item 2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 23 |
|             |                                                                                        |   |
| Item 3.          | Quantitative  and Qualitative Disclosures About Market Risk                                 | 30 |
|             |                                                                                        |   |
| Item 4.          | Controls and  Procedures                                                                    | 31 |
|             |                                                                                        |   |
| **PART II** |                                                                                        |
|             |                                                                                        |   |
| Item 1.          | Legal Proceedings                                                                           | 31 |
|             |                                                                                        |   |
| Item 1A.         | Risk Factors                                                                                | 32 |
|             |                                                                                        |   |
| Item 2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 32 |
|             |                                                                                        |   |
| Item 3.          | Defaults Upon  Senior Securities                                                            | 32 |
|             |                                                                                        |   |
| Item 4.          | Submission of  Matters to a Vote of Security Holders                                        | 32 |
|             |                                                                                        |   |
| Item 5.          | Other Information                                                                           | 32 |
|             |                                                                                        |   |
| Item 6.          | Exhibits                                                                                    | 33 |
|             |                                                                                        |   |
| **SIGNATURES**   |                                                                                        |

 

2

----

**PART I**

**Item 1.  Financial Statements**

**BPZ Energy, Inc. and Subsidiaries**

**(An Exploratory Stage Company)**

**Consolidated Balance Sheets**
| ** **                                                                                                                                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                              | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                              | ** ** | **(Unaudited)**        | ** ** | **(Audited)**         | ** ** |
| **ASSETS**                                                                                                                                                              | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Current assets:                                                                                                                                                         |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                              |       | $                      | 16,692,553 |                  | $          | 29,455,130 |   |
| Value added tax  receivable                                                                                                                                             |       | 1,420,763              |       | 362,555               |       |
| Inventory                                                                                                                                                               |       | 3,676,251              |       | —                |       |
| Prepaid and other  current assets                                                                                                                                       |       | 1,665,349              |       | 507,114               |       |
| Total current assets                                                                                                                                                    |       | 23,454,916             |       | 30,324,799            |       |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Property, equipment and  construction in progress, net                                                                                                                  |       | 23,101,282             |       | 4,365,040             |       |
| Restricted cash                                                                                                                                                         |       | 2,461,934              |       | 1,455,953             |       |
| Investment in Ecuador  property, net                                                                                                                                    |       | 1,804,500              |       | 1,945,188             |       |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Total assets                                                                                                                                                            |       | $                      | 50,822,632 |                  | $          | 38,090,980 |   |
|                                                                                                                                                                    |       |                   |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                          | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                    |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                        |       | $                      | 549,645    |                  | $          | 747,347 |   |
| Accrued liabilities                                                                                                                                                     |       | 3,258,004              |       | 470,632               |       |
| Other liabilities                                                                                                                                                       |       | 75,347                 |       | 70,516                |       |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Total current  liabilities                                                                                                                                              |       | 3,882,996              |       | 1,288,495             |       |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Long-term debt                                                                                                                                                          |       | 60,258                 |       | 70,908                |       |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Commitments and  contingencies (Note 10)                                                                                                                                |       |                   |       |                  |       |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                              |       |                   |       |                  |       |
| Preferred stock, no par  value, 25,000,000 authorized, none issued and outstanding                                                                                      |       | —                 |       | —                |       |
| Common stock, no par  value, 250,000,000 authorized; 47,350,163 and 40,349,979 shares issued and  outstanding at September 30, 2006 and December 31, 2005, respectively |       | 75,692,862             |       | 56,873,641            |       |
| Additional paid in  capital                                                                                                                                             |       | 6,640,925              |       | 6,393,411             |       |
| Deferred stock-based  compensation                                                                                                                                      |       | (1,468,821             | )          | (3,992,172            | )          |
| Stock subscription  receivable                                                                                                                                          |       | (230,825               | )          | (230,825              | )          |
| Deficit accumulated  during the exploratory stage                                                                                                                       |       | (33,754,763            | )          | (22,312,478           | )          |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Total stockholders’  equity                                                                                                                                        |       | 46,879,378             |       | 36,731,577            |       |
|                                                                                                                                                                    |       |                   |       |                  |       |
| Total liabilities and  stockholders’ equity                                                                                                                        |       | $                      | 50,822,632 |                  | $          | 38,090,980 |   |

 

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

3

----

**BPZ Energy, Inc. and Subsidiaries**

**(An Exploratory Stage Company)**

**ConsolidatedStatements of Operations**

**(Unaudited)**
| ** **                                                       | ** ** | **Cumulative**                | ** **  | ** **                       | ** ** | ** **                            | ** ** | ** **  | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------|-------------|----------------------------------|------------|---------------------------------------|------------|-------------|------------|------------|------------|
| ** **                                                       | ** ** | **Amounts from**         | ** **  | ** **                       | ** ** | ** **                            | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **August 20, 2001** | ** **  | ** **                       | ** ** | ** **                            | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                                                       | ** ** | **(Inception) to**       | ** **  | **Three Months Ended** | ** ** | **Nine Months Ended ** | ** ** |
| ** **                                                       | ** ** | **September 30,**        | ** **  | **September 30,**           | ** ** | **September 30,**                | ** ** |
| ** **                                                       | ** ** | **2006**                      | ** **  | **2006**                         | ** ** | **2005**                              | ** ** | **2006**    | ** ** | **2005**   | ** ** |
| ** **                                                       | ** ** | ** **                    | ** **  | ** **                       | ** ** | ** **                            | ** ** | ** **  | ** ** | ** ** | ** ** |
| Revenue                                                          |       | $                             | —      |                             | $          | —                                |       | $           | —     |       | $          | — |   | $ | — |   |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Operating and  administrative expenses:                          |       |                          |        |                             |       |                                  |       |        |       |       |       |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| General and administrative                                       |       | 12,991,088                    |        | 2,373,475                        |       | 900,136                               |       | 5,813,311   |       | 2,785,122  |       |
| Stock-based  compensation                                        |       | 10,671,530                    |        | 879,877                          |       | 526,000                               |       | 2,229,970   |       | 780,270    |       |
| Geological, geophysical  and engineering                         |       | 2,861,307                     |        | 638,504                          |       | 98,854                                |       | 1,502,211   |       | 528,045    |       |
| Depreciation expense                                             |       | 188,882                       |        | 63,850                           |       | 2,998                                 |       | 159,087     |       | 5,293      |       |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Total operating  expenses                                        |       | 26,712,807                    |        | 3,955,706                        |       | 1,527,988                             |       | 9,704,579   |       | 4,098,730  |       |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Operating loss                                                   |       | (26,712,807                   | )           | (3,955,706                       | )          | (1,527,988                            | )          | (9,704,579  | )          | (4,098,730 | )          |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Other income (expense):                                          |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Income from investment  in Ecuador property, net of amortization |       | 1,599,662                     |        | 395,217                          |       | 141,628                               |       | 983,075     |       | 304,057    |       |
| Interest expense                                                 |       | (107,953                      | )           | (27,007                          | )          | (388                                  | )          | (29,845     | )          | (8,355     | )          |
| Amortization of  deferred financing costs                        |       | (428,000                      | )           | —                           |       | (9,652                                | )          | —      |       | (67,562    | )          |
| Registration delay  expense                                      |       | (3,840,933                    | )           | (1,191,836                       | )          | —                                |       | (3,324,966  | )          | —     |       |
| Interest income                                                  |       | 1,154,366                     |        | 216,525                          |       | 212,073                               |       | 644,558     |       | 212,073    |       |
| Merger costs                                                     |       | (5,470,455                    | )           | —                           |       | —                                |       | —      |       | —     |       |
| Net gain on sale of  asset                                       |       | (150                          | )           | (150                             | )          | —                                |       | (150        | )          | —     |       |
| Miscellaneous income                                             |       | 51,507                        |        | (849                             | )          | 41,735                                |       | (10,378     | )          | 54,908     |       |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Total other income  (expense)                                    |       | (7,041,956                    | )           | (608,100                         | )          | 385,396                               |       | (1,737,706  | )          | 495,121    |       |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Loss before income  taxes                                        |       | (33,754,763                   | )           | (4,563,806                       | )          | (1,142,592                            | )          | (11,442,285 | )          | (3,603,609 | )          |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Income taxes                                                     |       | —                        |        | —                           |       | —                                |       | —      |       | —     |       |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Net loss                                                         |       | $                             | (33,754,763 | )                                | $          | (4,563,806                            | )          | $           | (1,142,592 | )          | $          | (11,442,285 | ) | $ | (3,603,609 | ) |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Basic and diluted net  loss per share                            |       |                          |        | $                                | (0.10      | )                                     | $          | (0.03       | )          | $          | (0.26      | ) | $ | (0.12 | ) |
|                                                             |       |                          |        |                             |       |                                  |       |        |       |       |       |
| Weighted average common  shares outstanding                      |       |                          |        | 47,320,202                       |       | 35,635,687                            |       | 43,593,613  |       | 29,152,437 |       |

 

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

4

----

**BPZ Energy, Inc. andSubsidiaries**

**(An Exploratory Stage Company)**

# **ConsolidatedStatements of Stockholders’ Equity**

**Nine Months EndedSeptember 30, 2006**

**(Unaudited)**
| ** **                                               | ** ** | ** **                        | ** ** | ** **  | ** ** | ** **      | ** ** | ** **       | ** ** | ** **      | ** ** | **Deficit**         | ** ** | ** **  | ** ** |
|----------------------------------------------------------|------------|-----------------------------------|------------|-------------|------------|-----------------|------------|------------------|------------|-----------------|------------|---------------------|------------|-------------|------------|
| ** **                                               | ** ** | ** **                        | ** ** | ** **  | ** ** | ** **      | ** ** | ** **       | ** ** | ** **      | ** ** | **Accumulated**     | ** ** | ** **  | ** ** |
| ** **                                               | ** ** | ** **                        | ** ** | ** **  | ** ** | **Additional**  | ** ** | **Deferred**     | ** ** | **Stock**       | ** ** | **During the** | ** ** | ** **  | ** ** |
| ** **                                               | ** ** | **Common Stock Issued** | ** ** | **Paid-in** | ** ** | **Stock-based** | ** ** | **Subscription** | ** ** | **Exploratory** | ** ** | ** **          | ** ** |
| ** **                                               | ** ** | **Shares**                        | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Compensation** | ** ** | **Receivable**  | ** ** | **Stage**           | ** ** | **Total**   | ** ** |
|                                                     |       |                              |       |        |       |            |       |             |       |            |       |                |       |        |       |
| Balances  at December 31, 2005 (Audited)            |       | 40,349,979                        |       | $           | 56,873,641 |            | $          | 6,393,411        |       | $               | (3,992,172 | )                   | $          | (230,825    | )          | $ | (22,312,478 | ) | $ | 36,731,577 |   |
|                                                     |       |                              |       |        |       |            |       |             |       |            |       |                |       |        |       |
| Stock-based  compensation                                |       | 10,000                            |       | 25,000      |       | 778,839         |       | 251,036          |       | —          |       | —              |       | 1,054,875   |       |
| Exercise  of stock options                               |       | 275,000                           |       | 882,750     |       | (882,750        | )          | —           |       | —          |       | —              |       | —      |       |
| Long-term  incentive plan                                |       | (200,000                          | )          | (1,200,000  | )          | 102,780         |       | 2,272,315        |       | —          |       | —              |       | 1,175,095   |       |
| Common  stock sold for cash, net of offering costs       |       | 6,152,000                         |       | 17,335,500  |       | —          |       | —           |       | —          |       | —              |       | 17,335,500  |       |
| Warrants  issued in connection with sale of common stock |       | —                            |       | (248,645    | )          | 248,645         |       | —           |       | —          |       | —              |       | —      |       |
| Common  stock issued for registration delay              |       | 763,184                           |       | 2,024,616   |       | —          |       | —           |       | —          |       | —              |       | 2,024,616   |       |
|                                                     |       |                              |       |        |       |            |       |             |       |            |       |                |       |        |       |
| Net  loss for the period                                 |       | —                            |       | —      |       | —          |       | —           |       | —          |       | (11,442,285         | )          | (11,442,285 | )          |
|                                                     |       |                              |       |        |       |            |       |             |       |            |       |                |       |        |       |
| Balances  at September 30, 2006                     |       | 47,350,163                        |       | $           | 75,692,862 |            | $          | 6,640,925        |       | $               | (1,468,821 | )                   | $          | (230,825    | )          | $ | (33,754,763 | ) | $ | 46,879,378 |   |

 

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

5

----

**BPZ Energy, Inc. andSubsidiaries**

**(An Exploratory Stage Company)**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**
| ** **                                                                                                       | ** ** | **Cumulative**                | ** **  | ** **                      | ** ** | ** **  | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|-------------|---------------------------------|------------|-------------|------------|
| ** **                                                                                                       | ** ** | **Amounts from**         | ** **  | ** **                      | ** ** | ** **  | ** ** |
| ** **                                                                                                       | ** ** | **August 20, 2001** | ** **  | ** **                      | ** ** | ** **  | ** ** |
| ** **                                                                                                       | ** ** | **(Inception) to**       | ** **  | **Nine Months Ended** | ** ** |
| ** **                                                                                                       | ** ** | **September 30,**        | ** **  | **September 30,**          | ** ** |
| ** **                                                                                                       | ** ** | **2006**                      | ** **  | **2006**                        | ** ** | **2005**    | ** ** |
| ** **                                                                                                       | ** ** | ** **                    | ** **  | ** **                      | ** ** | ** **  | ** ** |
| Net loss                                                                                                         |       | $                             | (33,754,763 | )                               | $          | (11,442,285 | )          | $ | (3,603,609 | ) |
| Adjustments to  reconcile net loss to net cash used by operating activities:                                     |       |                          |        |                            |       |        |       |
| Stock-based compensation                                                                                         |       | 10,671,530                    |        | 2,229,970                       |       | 780,270     |       |
| Stock issued in merger                                                                                           |       | 979,981                       |        | —                          |       | —      |       |
| Options assumed in  merger                                                                                       |       | 4,490,474                     |        | —                          |       | —      |       |
| Stock issued for  registration delay expense                                                                     |       | 2,296,576                     |        | 2,024,616                       |       | —      |       |
| Depreciation expense                                                                                             |       | 188,882                       |        | 159,087                         |       | 5,293       |       |
| Net gain on the sale of  assets                                                                                  |       | (150                          | )           | (150                            | )          |        |       |
| Amortization of  investment in Ecuador property                                                                  |       | 320,000                       |        | 140,688                         |       | 89,656      |       |
| Amortization of  deferred financing fees                                                                         |       | 428,000                       |        | —                          |       | 67,562      |       |
| Expenses paid by  affiliate                                                                                      |       | 629,596                       |        | —                          |       | —      |       |
| Changes in operating  assets and liabilities:                                                                    |       |                          |        |                            |       |        |       |
| Increase value added  tax receivable                                                                             |       | (1,420,763                    | )           | (1,058,208                      | )          | —      |       |
| Increase in inventory                                                                                            |       | (3,676,251                    | )           | (3,676,251                      | )          | —      |       |
| Increase in prepaid and  other current assets                                                                    |       | (1,665,349                    | )           | (1,158,235                      | )          | (504,289    | )          |
| Increase (decrease) in  accounts payable                                                                         |       | 549,645                       |        | (197,702                        | )          | (65,592     | )          |
| Increase in accrued  liabilities                                                                                 |       | 2,828,557                     |        | 2,357,927                       |       | 41,437      |       |
| Increase in other  liabilities                                                                                   |       | 75,347                        |        | 4,831                           |       | 22,324      |       |
| Net cash used by  operating activities                                                                           |       | (17,058,688                   | )           | (10,615,712                     | )          | (3,166,948  | )          |
|                                                                                                             |       |                          |        |                            |       |        |       |
| Cash flows from  investing activities:                                                                           |       |                          |        |                            |       |        |       |
| Property, equipment and  construction in progress additions                                                      |       | (22,861,569                   | )           | (18,466,734                     | )          | (2,891,885  | )          |
| Proceeds from the sale  of office equipment                                                                      |       | 1,000                         |        | 1,000                           |       | —      |       |
| Restricted cash                                                                                                  |       | (2,461,934                    | )           | (1,005,981                      | )          | (1,355,953  | )          |
| Investment in Ecuador  property                                                                                  |       | (1,440,000                    | )           | —                          |       | —      |       |
| Net cash used by  investing activities                                                                           |       | (26,762,503                   | )           | (19,471,715                     | )          | (4,247,838  | )          |
|                                                                                                             |       |                          |        |                            |       |        |       |
| Cash flows from  financing activities:                                                                           |       |                          |        |                            |       |        |       |
| Borrowings                                                                                                       |       | 2,226,826                     |        | —                          |       | —      |       |
| Repayments of  borrowings                                                                                        |       | (461,039                      | )           | (10,650                         | )          | (208,986    | )          |
| Proceeds from exercise  of warrants, net                                                                         |       | 3,868,260                     |        | —                          |       | 2,398,280   |       |
| Proceeds from sale of  common stock, net                                                                         |       | 54,879,697                    |        | 17,335,500                      |       | 31,917,213  |       |
| Net cash provided by  financing activities                                                                       |       | 60,513,744                    |        | 17,324,850                      |       | 34,106,507  |       |
|                                                                                                             |       |                          |        |                            |       |        |       |
| Net increase (decrease)  in cash and cash equivalents                                                            |       | 16,692,553                    |        | (12,762,577                     | )          | 26,691,721  |       |
| Cash and cash  equivalents at beginning of period                                                                |       | —                        |        | 29,455,130                      |       | 4,014,191   |       |
| Cash and cash  equivalents at end of period                                                                      |       | $                             | 16,692,553  |                            | $          | 16,692,553  |       | $ | 30,705,912 |   |
|                                                                                                             |       |                          |        |                            |       |        |       |
| Supplemental cash flow  information:                                                                             |       |                          |        |                            |       |        |       |
| **Cash paid for:**                                                                                               | ** ** | ** **                    | ** **  | ** **                      | ** ** | ** **  | ** ** |
| Interest                                                                                                         |       | $                             | 107,549     |                            | $          | 29,845      |       | $ | 10,968 |   |
| **Non — cash items:**                                                                                       | ** ** | ** **                    | ** **  | ** **                      | ** ** | ** **  | ** ** |
| Common stock issued for  property interest                                                                       |       | $                             | 1,112,500   |                            | $          | —      |       | $ | 1,112,500 |   |
| Warrants issued to  private placement agent                                                                      |       | 573,645                       |        | 248,645                         |       | 325,000     |       |
| Imputed financing costs                                                                                          |       | 428,000                       |        | —                          |       | —      |       |
| Conversion of long-term  debt to common stock                                                                    |       | 685,000                       |        | —                          |       | —      |       |
| Conversion of notes  payable to common stock                                                                     |       | 1,020,529                     |        | —                          |       | —      |       |
| Capital expenditures  for property, equipment and construction work in progress included in accrued  liabilities |       | 429,445                       |        | 429,445                         |       | —      |       |

 

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

6

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**BPZ Energy, Inc. and Subsidiaries**

**(An Exploratory Stage Company)**

**Notes ToConsolidated Financial Statements**

**September 30, 2006 and 2005**

**(Unaudited)**

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

**Organization**

BPZEnergy, Inc., a Colorado corporation (“BPZ” or the “Company”) wasincorporated in 1993 and is based in Houston, Texas. BPZ is an exploratorystage company with properties in northwest Peru and southwest Ecuador and isfocused on the exploration and production of oil and natural gas and thecomplementary development of gas-fired power generation.

OnSeptember 10, 2004, BPZ Energy, Inc., a Texas corporation (“BPZ-Texas”),consummated a reverse merger with Navidec, Inc. (“Navidec”) wherebyBPZ-Texas became a wholly owned subsidiary of Navidec (the “Merger”).  However, in the Merger, the stockholder groupof BPZ-Texas obtained majority ownership and management control of the combinedcompany. The Merger was treated, for accounting purposes, as a capitaltransaction rather than a business combination. This is equivalent to the issuance of common stock by BPZ-Texas for thenet assets of Navidec, accompanied by a recapitalization.  This accounting treatment is identical tothat resulting from a reverse merger under SFAS No. 141, Business Combinations,except that no goodwill or other intangible asset has been recorded. Allfinancial statements presented herein represent the historical financialstatements of the accounting acquirer, BPZ-Texas.  Although the Company’s name has been changed,the pre-merger company may be referred to as Navidec in this filing, as thecontext may require, to avoid confusion.

The Merger required thetransfer of all of the pre-merger business operations, assets and liabilitiesof Navidec to its wholly owned subsidiary, Navidec Financial Services, Inc. (“NFS”),and the transfer of ownership of NFS to the shareholders of record of Navidecas of September 9, 2004, the day prior to the consummation of the Merger.Accordingly, the pre-merger shareholders of BPZ-Texas were not entitled toreceive shares of NFS.  Upon consummationof the Merger, the Company became contractually and irrevocably bound to thespin-off of NFS to such pre-merger shareholders. All legal requirements for thetransfer of ownership of NFS have been completed except for registration of theNFS shares with the Securities and Exchange Commission (“SEC”). The Company hasno control over the registration process of NFS and cannot predict when, or if,the management of NFS will complete the registration of NFS common shares.  NFS’ results are excluded from the Company’sfinancial statements for all periods presented.

TheCompany maintains a registered branch office in Peru.  Currently, BPZ has exclusive rights andlicense agreements for oil and gas exploration and production covering a totalof approximately 2.4 million acres in northwest Peru.  The Company’s license contracts cover 100%ownership of both Block Z-1 (739,205 acres), which was signed inNovember 2001 and Block XIX (472,860 acres), which was signed inDecember 2003. The license contracts provide for an initial exploration periodof seven to thirteen years and seven to ten years, respectively and requirethat we conduct specified activities on the properties during this period.  If the exploration activities are successful,the total contract term may be extended up to 30 years for oil exploration andproduction and up to 40 years for gas exploration and production.  BPZ has presented all necessary documentationrequested by Perupetro in order to become the qualified operator under a licensecontract for Block XXII (948,000 acres) which BPZ previously held under aTechnical Evaluation Agreement and was referred to as Area VI in the Company’sprevious filings.  In July 2006 Perupetroofficially informed the Company that its proposal for the 248,000 acre BlockXXIII, located onshore in northwest Peru between the Company’s Blocks Z-1 andXIX, was the winning bid in Perupetro’s recent tender process.  The Company has presented all necessarydocumentation to become the qualified operator of this new block under anexploration and production license contract.

BPZthrough its wholly owned subsidiary, SMC Ecuador Inc. (a Delaware corporation),and its registered branch in Ecuador, also owns a 10% non-operating workinginterest in an oil and gas producing property, Block 2, located in thesouthwest region of Ecuador (the “Santa Elena Property”).  The license agreement covering the propertyextends through May 2016.

BPZis currently in the exploratory stage and to date its activities in Peru havebeen limited to analysis and evaluation of technical data on the properties andpreparation of the development plans for the properties, including detailedengineering and design of the power plant and gas processing facilities,refurbishment of one of its offshore platforms, 

7

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procuringmachinery and equipment for a drilling campaign, obtaining all necessaryenvironmental and operating permits, and securing the required capital andfinancing to complete the current plan of operation. The Company began drillingoperations on its first well in September, 2006.  The Company does not anticipate generatingsignificant revenues from its properties prior to the fourth quarter of 2007.

**Basisof Presentation**

The Company’s unauditedconsolidated financial statements included herein have been prepared pursuant tothe rules and regulations of the Securities and Exchange Commission as theypertain to Form 10-Q.  Accordingly,certain information and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States have been condensed or omitted pursuant to such rules andregulations.  The unaudited financialstatements reflect all adjustments which are, in the opinion of management,necessary for a fair presentation of the financial position and results ofoperations for the interim periods on a basis consistent with the annualaudited financial statements.  Except forthe restatement described in Note 2 to the Consolidated Financial Statements,all such adjustments are of a normal recurring nature. The Company believesthat the disclosures contained herein are adequate to make the informationpresented not misleading.  Theconsolidated balance sheet at December 31, 2005 is derived from the December31, 2005 audited consolidated financial statements, as restated.  These interim financial statements should beread in conjunction with the consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-KSB/A for the yearended December 31, 2005 filed on October 16, 2006.  The results of operations for interim periodsare not necessarily indicative of the results to be expected for the full year.

Certainreclassifications of prior year balances have been made to conform such amountsto corresponding 2006 classifications. These reclassifications have no impacton net income.

**NewAccounting Pronouncements**

Thefollowing are recent accounting pronouncements affecting the Company’sactivities and operations:

In September 2006, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.157 – *Fair Value Measurement*.  SFAS No. 157 defines fair value, establishesa framework for measuring fair value in generally accepted accountingprinciples, and expands disclosures about fair value measurements. SFAS No. 157applies under other accounting pronouncements that require or permit fair valuemeasurements, the FASB having previously concluded in those accountingpronouncements that fair value is the relevant measurement attribute.Accordingly, SFAS No.157 does not require any new fair value measurements.However, for some entities, the application of this SFAS 157 No. 157 willchange current practice.  The definitionof fair value focuses on the price that would be received to sell the asset orpaid to transfer the liability (an exit price), not the price that would bepaid to acquire the asset or received to assume the liability (an entryprice).  SFAS No. 157 emphasizes thatfair value is a market-based measurement, not an entity-specificmeasurement.  The provisions of thisStatement will be effective for financial statement issued for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscal years.

**Stock-Based Compensation**

On January 1, 2006, the Company adopted Statement of FinancialAccounting Standards (“SFAS”) No. 123 — Revised 2004,*Share—Based Payment* (“SFAS 123(R)”),which establishes accounting for stock-based payment transactions for employeeservices and goods and services received from non-employees. SFAS 123(R) is arevision of SFAS No. 123, *Accountingfor Stock-Based Compensation* (“SFAS 123”), and supersedes APBNo. 25, *Accounting for Stock Issued toEmployees*. Under the provisions of SFAS 123(R), stock-basedcompensation cost is measured at the date of grant, based on the calculatedfair value of the award, and is recognized as expense over the employee’s ornon-employee’s service period, which is generally the vesting period of theequity grant.

Prior to January 1, 2006, the Company accounted for stock-basedcompensation in accordance with SFAS 123. As allowed under SFAS 123, the Company accounted for its stock-basedcompensation to employees using the intrinsic value method of accounting whichbases compensation expense on the difference between the quoted market price ofthe award at the measurement date less the amount, if any, the employee isrequired to pay for the stock.  As ofJanuary 1, 2006, stock-based awards to employees consisted of only restrictedshares valued using the market price of the Company’s traded common stock onthe date of grant. The fair value method used to value restricted shares wouldhave yielded the same fair 

8

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value and compensation expense as the intrinsic value method used;thus, no pro forma results of operations are required to be presented.

In addition, stock-basedawards to non-employees as of January 1, 2006 consisted of options andrestricted shares issued in exchange for various legal and investment bankingservices.  Equity instruments issued tonon-employees for services were accounted for at fair value at the date ofgrant.  The fair value for awards issuedto non-employees was measured using a Black-Scholes valuation model.  Expenses determined for employees andnon-employees were recognized in the Company’s financial statements over theapplicable service period.

TheCompany adopted SFAS 123(R) using the modified prospective application methodand, accordingly, no prior periods have been restated as a result of theadoption of this pronouncement. Under this method, compensation cost recognizedduring the three and nine months ended September 30, 2006 included:(a) compensation cost for all stock-based payments granted prior to, butnot yet vested as of January 1, 2006, based on the grant-date fair valueestimated in accordance with the original provisions of SFAS 123; and (b)compensation cost for all stock-based payments granted after January 1,2006, based on the grant-date fair value estimated in accordance with SFAS123(R). SFAS 123(R) requires forfeitures to be estimated at the time of grantand revised, if necessary, in subsequent periods to reflect actualforfeitures.   The Company’s forfeitureestimates were not changed as a result of adopting SFAS 123(R).

The following tablesummarizes stock-based compensation costs recognized under SFAS 123(R) for thethree and nine months ended September 30, 2006 and under SFAS 123 for three andnine months ended September 30, 2005:
|                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                    | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                          |       |                             |       |                            |       |   |   |   |   |
| Employee  stock—based compensation costs |       | $                                | 820,772    |                            | $          | 368,500 |   | $ | 1,980,280 |   | $ | 368,500 |   |
| Non-employee  stock-based compensation        |       | 59,105                           |       | 157,500                         |       | 249,690 |   | 411,770 |   |
|                                          |       | $                                | 879,877    |                            | $          | 526,000 |   | $ | 2,229,970 |   | $ | 780,270 |   |

 

See Note 9 to theConsolidated Financial Statements, included in this filing, for detaileddiscussion regarding the Company’s employee long-term incentive compensationplan and stock-based payments to non-employees.

*Restricted Stock Awards and Performance Shares*

TheCompany determines the fair value of restricted stock awards and performanceshares based on the market price of the Company’s common stock on the date ofgrant. Compensation cost for such awards is recognized on a straight-line basisover the vesting or service period, net of forfeitures; however, compensationcost related to performance shares will not be recorded or will be reversed ifthe Company does not believe it is probable that such performance criteria willbe met or if the service provider (employee or otherwise) fails to meet suchcriteria.

Asummary of the Company’s restricted stock award activity and relatedinformation is presented below:
|                                               | ** ** | ** **         | ** ** | **Weighted—**  | ** ** |
|-----------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                    | ** ** | **Number of** | ** ** | **Average**         | ** ** |
| ** **                                    | ** ** | **Restricted**     | ** ** | **Fair Value** | ** ** |
| ** **                                    | ** ** | **Shares**         | ** ** | **Per Share**  | ** ** |
| Non-vested  balance at December 31, 2005 |       | 1,130,000          |       | $                   | 4.40       |   |
| Granted                                       |       | 100,000            |       | 3.44                |       |
| Vested                                        |       | (345,000           | )          | 4.40                |       |
| Forfeited                                     |       | (300,000           | )          | 4.40                |       |
| Non-vested balance at  September 30, 2006     |       | 585,000            |       | $                   | 4.24       |   |

 

Asof September 30, 2006, there was $1.7 million of total unrecognizedcompensation cost related to nonvested restricted stock awards, which isexpected to be recognized over a weighted-average period of 1.5 years.

Noperformance shares were outstanding as of September 30, 2006.

9

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*Stock Options*

Incentiveand non-qualified stock options issued to directors, officers, employees andconsultants are issued at an exercise price equal to the fair market value ofthe stock at the date of grant.  Themajority of the Company’s stock options vest pro-rata over two years from thegrant date and generally expire ten years from the date of grant.  Compensation cost related to stock options isrecognized on a straight-line basis over the vesting or service period and isnet of forfeitures.

Thefair value of each stock option granted is estimated on the date of grant usinga Black-Scholes option pricing model. The following table presents theweighted-average assumptions used in the option pricing model for optionsgranted during the nine months ended September 30, 2006. During the ninemonths ended September 30, 2005, no options were granted by the Company. Theexpected life of the options represents the period of time the options areexpected to be outstanding. For the nine months ended September 30, 2006,the expected term of options granted was derived based on a weighting between(a) the Company’s historical exercise and forfeiture activity and (b) theaverage midpoint between vesting and the contractual term. In the future, asinformation regarding post-vesting termination becomes more accessible, theCompany may change the method of deriving the expected term. This change couldimpact the fair value of options granted in the future. The Company expects torefine the method of deriving the expected term no later than January 1,2008.  For the nine months endedSeptember 30, 2006, our expected volatility is based on the historicalvolatility of our stock for a period approximating the expected life.  The risk-free interest rate is based on theobserved U.S. Treasury yield curve in effect at the time the options weregranted. The dividend yield is based on our history of dividend payouts.
| ** **                                          | ** ** | **2006** | ** ** |
|-----------------------------------------------------|------------|----------|------------|
| Expected life (years)                               |       | 6        |       |
| Risk-free interest rate                             |       | 4.9      | %          |
| Volatility                                          |       | 69.5     | %          |
| Dividend yield                                      |       | 0        | %          |
| Weighted-average fair value per share at grant date |       | $        | 3.36       |   |
|                                                     |            |          |            |  |

 

A summary of ourstock option activity and related information is presented below (in thousands,except per option prices):
| ** **                                    | ** ** | ** **         | ** ** | **Weighted—**      | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | ** **         | ** ** | **Average**             | ** ** |
| ** **                                    | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| ** **                                    | ** ** | **Options**        | ** ** | **Per Option**     | ** ** |
| Non-vested balance at  December 31, 2005 |       | 500,000            |       | $                       | 1.30       |   |
| Granted                                       |       | 1,480,000          |       | 3.36                    |       |
| Vested                                        |       | —             |       | —                  |       |
| Non-vested balance at September 30, 2006      |       | 1,980,000          |       | $                       | 2.84       |   |

 

Nooptions were exercised during the nine months ended September 30, 2006. Asof September 30, 2006, there was $2.6 million of total unrecognizedcompensation cost related to nonvested stock options which is expected to berecognized over a weighted-average period of 1.6 years.

Pursuantto a Settlement Agreement and Mutual Release entered into on May 19, 2006between the Company, Mr. McKowen and NFS, the vesting period related to the500,000 nonvested options outstanding as of December 31, 2005, which remainedunvested and outstanding as of September 30, 2006, was extended from September10, 2006 to one year following the effective date of the registration with theSEC of the shares NFS received in the Merger with Navidec, which as of the dateof this filing, have not yet been registered. The extension of the vesting period did not result in a revaluation ofthese options, as the number of options that the Company expects to vest didnot change as a result of the modification.

10

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Thefollowing table summarizes information about stock options outstanding as ofSeptember 30, 2006:
|                                             | ** ** | **Outstanding**    | ** ** | **Exercisable**     | ** ** |
|---------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                  | ** ** | ** **         | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **         | ** ** | **Weighted-**       | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **         | ** ** | **Average**         | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                  | ** ** | ** **         | ** ** | **Remaining**       | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | **Number of** | ** ** | **Contractual**     | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| **Range of Exercise Prices** | ** ** | **Options**        | ** ** | **Life**            | ** ** | **Options** | ** ** | **Per Option** | ** ** |
| ** **                                  | ** ** | ** **         | ** ** | **(In years)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 1.30                                        |       | 1,000,000          |       | 7.9                 |       | 500,000 |   | $ | 1.30 |   |
| 2.00                                        |       | 1,225,000          |       | 7.9                 |       | 1,225,000 |   | 2.00 |   |
| 3.20                                        |       | 580,000            |       | 9.5                 |       | — |   | — |   |
| 3.35                                        |       | 750,000            |       | 9.7                 |       | — |   | — |   |
| 4.00                                        |       | 150,000            |       | 9.8                 |       | — |   | — |   |
| Total(1)                                    |       | 3,705,000          |       | 8.6                 |       | 1,725,000 |   | $ | 1.80 |   |

----

(1)    378,652 outstandingoptions have been excluded from this total as they relate to options assumed inthe Company’s Merger with Navidec. These options have no impact on earnings.See Note 9 “Stock Options Outstanding’’ for further information.

Theaggregate intrinsic value of stock options outstanding at September 30,2006 was $8.3 million, of which $6.5 million relates to awards vested andexercisable and $1.8 million relates to awards expected to vest. Theintrinsic value for stock options outstanding is calculated as the amount bywhich the quoted price of our common stock as of September 29, 2006exceeds the exercise price of the option.

*Warrants*

As of September 30, 2006,the Company had 250,000 warrants outstanding. For their role as placement agent, in connection with the privateplacement of 11,466,000 shares of common stock in July 2005, MorganKeegan & Company, Inc. received fully vested warrants to purchase100,000 shares of the Company’s common stock at an exercise price of $3.00 pershare. Such warrants expire on July 19, 2010. These warrants were valuedat $325,000 using the Black-Scholes model, which amount was treated asadditional 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, MorganKeegan & Company, Inc., received fully vested warrants topurchase 150,000 shares of the Company’s common stock at an exercise price of$3.00 per share. Such warrants expire on June 30, 2011. These warrants werevalued at $248,645 using the Black-Scholes model, which amount was treated asadditional non-cash stock offering costs.

All warrants issued werevalued using the Black-Scholes model, which amount was treated as additionalnon-cash stock offering costs.  Thefollowing table presents the weighted-average assumptions used in the optionpricing model for options granted during the nine months endedSeptember 30, 2006 and 2005.  Thesame methodologies applied to determine the assumptions used to value theoptions noted above were also used in valuing the warrants issued to MorganKeegan & Company.
|                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Expected life  (years)                               |       | 1.6      |       | 1.9      |       |
| Risk-free  interest rate                             |       | 4.9      | %          | 2.50     | %          |
| Volatility                                           |       | 64.7     | %          | 76.12    | %          |
| Dividend yield                                       |       | 0        | %          | 0        | %          |
| Weighted-average fair  value per share at grant date |       | $        | 1.66       |     | $          | 3.25 |   |
|                                                      |            |          |            |          |            |  |  |

 

No warrants were exercised during the nine monthsended September 30, 2006.

**Note 2 — October 2006 Restatement**

Thepreviously issued consolidated financial statements of the Company as ofDecember 31, 2005 and for the three and nine month periods ended September30, 2005 have been restated in the Company’s 10 KSB/A filed on October 16,2006, in connection with the issues described below:

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·                  with respect tothe merger with Navidec, Inc., the description of the accounting and thevaluation of certain Navidec options assumed by the Company;

·                  the accountingfor the post-merger operations of Navidec Financial Services, Inc.; and

·                  the accounting for expenses incurredon the Company’s behalf by its former parent, BPZ & Associates, Inc. (“Associates”)prior to the merger with Navidec.

*The Navidec Merger*

The Company’s descriptionof the transaction was revised to clarify that the merger is considered, froman accounting perspective to be in substance, a capital transaction rather thana business combination.  On July 8, 2004, Navidec and BPZ-Texasentered into a Merger Agreement (the “Merger Agreement”) providing for theacquisition of BPZ-Texas by Navidec in a transaction intended to qualify as atax free share exchange (the “Merger”). The Merger was consummated on September 10, 2004. TheCompany changed its name from Navidec, Inc. to BPZ Energy, Inc. onFebruary 4, 2005.  Although theCompany’s name has been changed, the pre-merger company may be referred to asNavidec in this filing, as the context may require, to avoid confusion.

TheMerger was structured from a legal standpoint as the acquisition of BPZ-Texasby Navidec; however, the stockholder group of BPZ-Texas obtained majorityownership and management control of the combined company.  It was equivalent to the issuance of commonstock by BPZ-Texas for the net assets of Navidec, accompanied by a recapitalization.  The accounting treatment is identical to thatresulting from a reverse merger of BPZ-Texas with Navidec under SFAS 141,except that no goodwill or other intangible asset was recorded.

TheCompany’s historical financial statements prior to the acquisition became thoseof BPZ-Texas (accounting acquirer). Operations prior to the Merger are those ofBPZ-Texas and earnings per share for periods prior to the Merger are restatedto reflect the number of equivalent shares received by BPZ-Texas, with thehistorical stockholders’ equity of BPZ-Texas prior to the Merger beingretroactively restated (a recapitalization) to reflect the equivalent number ofshares received in the Merger by BPZ-Texas and the capital structure (thenumber and type of shares issued) of Navidec (the legal acquirer). Accordingly,all financial statements included herein or incorporated by reference reflectthe acquisition by BPZ-Texas of the net assets of Navidec and therecapitalization of BPZ-Texas’ common stock based on the exchange ratioprovided in the Merger Agreement.

*NavidecOptions*

TheCompany also restated its consolidated financial statements to reflect a changein the valuation of the options to purchase 1,332,076 shares of Navidec commonstock assumed by the Company in the Merger with Navidec.  All shares underlying such options areissuable as common stock of the Company. The proceeds from the exercise of the assumed options must be remittedto NFS pursuant to the Merger Agreement. Accordingly, the Company believes that $0.00 should be the exerciseprice input in the Black-Scholes Model used to value these instruments.  In its prior restatement on Form 8-K/A filedJanuary 17, 2006, the Company used the stated exercise price (weighted average)per the respective option agreements. The fair value of these options was determined to be $3.21 (compared to$1.48 in the Company’s prior restatement) based on the exercise price noted andthe market price of the underlying common stock on the date of grant, amongother Black-Scholes inputs.

*Operationsof NFS*

TheCompany also restated its consolidated financial statements to exclude theoperations of NFS for all periods presented. The Merger Agreement provided that all of the pre-merger businessoperations, assets and liabilities of Navidec would be transferred to a wholly-ownedsubsidiary, NFS, followed by the transfer of ownership of NFS to the pre-mergershareholders of record as of September 9, 2004, the day prior to theconsummation of the Merger.  The Company previously concluded in its 2004Form 10-KSB/A filed on January 17, 2006 that it was the record owner of NFSshares, but that any ownership was at most temporary, and restated itsconsolidated financial statements to account for NFS on the equity method untilsuch time as the final distribution of NFS shares to the pre-mergershareholders had been completed in all respects.  The Company subsequently learned throughdiscovery performed with respect to an action the Company filed against NFS inDistrict Court, Arapahoe County, Colorado (the “Court”) that new share certificatesof NFS were issued in the names of the shareholders of the pre-merger Navideceffective September 9, 2004 and no NFS certificates were ever issued to theCompany.  Further, a Findings of Fact andConclusions of Law (the “Order”) issued by the Court determined that the

12

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Company was not ashareholder of NFS at any time after September 9, 2004.  Based on these findings, the Company hasconcluded it should not account for the post-Merger operations of NFS in theCompany’s consolidated financial statements.

*Allocation of Costs Incurred by Associates*

The Company also restatedits consolidated financial statements as a result of a change in themethodology used to allocate certain costs from Associates, its formerparent.  The Company has identified costsincurred by Associates in support of BPZ-Texas’ activities from BPZ-Texas’inception in August 2001 until the merger with Navidec on September 10, 2004.Specific costs incurred by Associates on behalf of BPZ-Texas have been includedin BPZ-Texas’ financial statements. Additionally, all of Associates’ costs onBPZ-Texas’ projects in excess of third party reimbursements have been includedin BPZ-Texas’s financial statements in an effort to reflect all the costs ofdoing business.  The Company believes itsallocation methodology is reasonable.

The effects of therestatement and any reclassification on the December 31, 2005 consolidatedbalance sheet were as follows:
| ** **                                                                                                             | ** ** | **December 31, 2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                             | ** ** | **As Reported**            | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
|                                                                                                                   |       |                            |       |   |   |   |   |
| **ASSETS**                                                                                                             | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current assets:                                                                                                        |       |                            |       |   |   |   |   |
| Cash and cash equivalents                                                                                              |       | $                               | 29,455,130 |   | $ | — |   | $ | 29,455,130 |   |
| Other                                                                                                                  |       | 869,669                         |       | — |   | 869,669 |   |
| Total current assets                                                                                                   |       | 30,324,799                      |       | — |   | 30,324,799 |   |
|                                                                                                                   |       |                            |       |   |   |   |   |
| Property,  equipment and construction in progress, net                                                                 |       | 4,365,040                       |       | — |   | 4,365,040 |   |
| Restricted cash                                                                                                        |       | 1,455,953                       |       | — |   | 1,455,953 |   |
| Investment in  Ecuador property, net                                                                                   |       | 1,945,188                       |       | — |   | 1,945,188 |   |
|                                                                                                                   |       |                            |       |   |   |   |   |
| Total assets                                                                                                           |       | $                               | 38,090,980 |   | $ | — |   | $ | 38,090,980 |   |
|                                                                                                                   |       |                            |       |   |   |   |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                          | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current  liabilities:                                                                                                  |       |                            |       |   |   |   |   |
| Accounts payable                                                                                                       |       | $                               | 747,347    |   | $ | — |   | $ | 747,347 |   |
| Accrued liabilities                                                                                                    |       | 470,632                         |       | — |   | 470,632 |   |
| Other liabilities                                                                                                      |       | 70,516                          |       | — |   | 70,516 |   |
| Total current liabilities                                                                                              |       | 1,288,495                       |       | — |   | 1,288,495 |   |
|                                                                                                                   |       |                            |       |   |   |   |   |
| Long-term debt                                                                                                         |       | 70,908                          |       | — |   | 70,908 |   |
|                                                                                                                   |       |                            |       |   |   |   |   |
| Stockholders’  equity:                                                                                            |       |                            |       |   |   |   |   |
| Preferred stock, no par value, 25,000,000  authorized, none issued and outstanding                                     |       | —                          |       | — |   | — |   |
| Common stock, no par value, 250,000,000 authorized;  and 40,349,979 shares issued and outstanding at December 31, 2005 |       | 60,633,684                      |       | (3,760,043 | ) | 56,873,641 |   |
| Additional paid in capital                                                                                             |       | 2,362,283                       |       | 4,031,128 |   | 6,393,411 |   |
| Deferred stock-based compensation                                                                                      |       | (3,992,172                      | )          | — |   | (3,992,172 | ) |
| Common stock and warrants held by affiliate                                                                            |       | (2,458,975                      | )          | 2,458,975 |   | — |   |
| Stock subscription receivable                                                                                          |       | (230,825                        | )          | — |   | (230,825 | ) |
| Deficit accumulated during the exploratory stage                                                                       |       | (19,582,418                     | )          | (2,730,060 | ) | (22,312,478 | ) |
|                                                                                                                   |       |                            |       |   |   |   |   |
| Total stockholders’ equity                                                                                        |       | 36,731,577                      |       | — |   | 36,731,577 |   |
|                                                                                                                   |       |                            |       |   |   |   |   |
| Total  liabilities and stockholders’ equity                                                                       |       | $                               | 38,090,980 |   | $ | — |   | $ | 38,090,980 |   |

13

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The effects of the restatementand any reclassification on the unaudited consolidated statement of operationsfor the nine and three months ended September 30, 2005 were as follows:
| ** **                                   | ** ** | **Nine Months Ended September 30, 2005** | ** ** | **Three Months Ended September 30, 2005** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **As Reported**                                              | ** ** | **Adjustment**                                                     | ** ** | **As Restated** | ** ** | **As Reported** | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| ** **                                   | ** ** | ** **                                                        | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                      |       | $                                                                 | —     |                                                               | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                         |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Operating and administrative expenses:       |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| General and administrative                   |       | 2,785,122                                                         |       | —                                                             |       | 2,785,122 |   | 900,136 |   | — |   | 900,136 |   |
| Stock-based compensation                     |       | 780,270                                                           |       | —                                                             |       | 780,270 |   | 526,000 |   | — |   | 526,000 |   |
| Geological, geophysical and engineering      |       | 528,045                                                           |       | —                                                             |       | 528,045 |   | 98,854 |   | — |   | 98,854 |   |
| Depreciation expense                         |       | 5,293                                                             |       | —                                                             |       | 5,293 |   | 2,998 |   | — |   | 2,998 |   |
| Total operating expenses                     |       | 4,098,730                                                         |       | —                                                             |       | 4,098,730 |   | 1,527,988 |   | — |   | 1,527,988 |   |
| Operating loss                               |       | (4,098,730                                                        | )          | —                                                             |       | (4,098,730 | ) | (1,527,988 | ) | — |   | (1,527,988 | ) |
|                                         |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Other income (expense):                      |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income from investment in Ecuador            |       | 304,057                                                           |       | —                                                             |       | 304,057 |   | 141,628 |   | — |   | 141,628 |   |
| Equity in loss of NFS                        |       | (1,733,717                                                        | )          | 1,733,717                                                          |       | — |   | (762,823 | ) | 762,823 |   | — |   |
| Loss on issuance of equity securities by NFS |       | —                                                            |       | —                                                             |       | — |   | 49,414 |   | (49,414 | ) | — |   |
| Interest expense                             |       | (8,355                                                            | )          | —                                                             |       | (8,355 | ) | (388 | ) | — |   | (388 | ) |
| Amortization of deferred financing costs     |       | (67,562                                                           | )          | —                                                             |       | (67,562 | ) | (9,652 | ) | — |   | (9,652 | ) |
| Interest income                              |       | 212,073                                                           |       | —                                                             |       | 212,073 |   | 212,073 |   | — |   | 212,073 |   |
| Miscellaneous income                         |       | 54,908                                                            |       | —                                                             |       | 54,908 |   | 41,735 |   | — |   | 41,735 |   |
| Total other income (expense)                 |       | (1,238,596                                                        | )          | 1,733,717                                                          |       | 495,121 |   | (328,013 | ) | 713,409 |   | 385,396 |   |
|                                         |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Loss before income taxes                     |       | (5,337,326                                                        | )          | 1,733,717                                                          |       | (3,603,609 | ) | (1,856,001 | ) | 713,409 |   | (1,142,592 | ) |
|                                         |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income taxes                                 |       | —                                                            |       | —                                                             |       | — |   | — |   | — |   | — |   |
| Net loss                                     |       | $                                                                 | (5,337,326 | )                                                                  | $          | 1,733,717 |   | $ | (3,603,609 | ) | $ | (1,856,001 | ) | $ | 713,409 |   | $ | (1,142,592 | ) |
|                                         |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Basic and diluted net loss per share         |       | $                                                                 | (0.23      | )                                                                  | $          | 0.06 |   | $ | (0.12 | ) | $ | (0.05 | ) | $ | 0.02 |   | $ | (0.03 | ) |
|                                         |       |                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Weighted average  common shares outstanding  |       | 22,737,131                                                        |       | 6,415,306                                                          |       | 29,152,437 |   | 35,169,900 |   | 465,787 |   | 35,635,687 |   |

 

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The effects of therestatement and any reclassification on the unaudited consolidated statement ofcash flows for the nine months ended September 30, 2005 were as follows:
| ** **                                                                   | ** ** | **For Nine Months Ended September 30, 2005** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **As Reported**                                                       | ** ** | **Adjustment** | ** ** | **As Restated** | ** ** |
| ** **                                                                   | ** ** | ** **                                                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                       |       |                                                                       |       |   |   |   |   |
| Net loss                                                                     |       | $                                                                          | (5,337,326 | ) | $ | 1,733,717 |   | $ | (3,603,609 | ) |
| Adjustments to  reconcile net loss to net cash used by operating activities: |       |                                                                       |       |   |   |   |   |
| Stock-based  compensation                                                    |       | 780,270                                                                    |       | — |   | 780,270 |   |
| Depreciation  expense                                                        |       | 5,293                                                                      |       | — |   | 5,293 |   |
| Amortization of  investment in Ecuador property                              |       | 89,656                                                                     |       | — |   | 89,656 |   |
| Amortization of  deferred financing fees                                     |       | 67,562                                                                     |       | — |   | 67,562 |   |
| Equity in loss  of Navidec Financial Services                                |       | 1,733,717                                                                  |       | (1,733,717 | ) | — |   |
| Changes in  operating assets and liabilities:                                |       |                                                                       |       |   |   |   |   |
| Increase in  prepaid and other current assets                                |       | (504,289                                                                   | )          | — |   | (504,289 | ) |
| Decrease in  accounts payable                                                |       | (65,592                                                                    | )          | — |   | (65,592 | ) |
| Decrease in  accrued liabilities                                             |       | 41,437                                                                     |       | — |   | 41,437 |   |
| Increase in  other liabilities                                               |       | 22,324                                                                     |       | — |   | 22,324 |   |
| Net cash used by  operating activities                                       |       | (3,166,948                                                                 | )          | — |   | (3,166,948 | ) |
|                                                                         |       |                                                                       |       |   |   |   |   |
| Cash flows from  investing activities:                                       |       |                                                                       |       |   |   |   |   |
| Property and  equipment additions                                            |       | (2,891,885                                                                 | )          | — |   | (2,891,885 | ) |
| Restricted cash                                                              |       | (1,355,953                                                                 | )          | — |   | (1,355,953 | ) |
| Net cash used by  investing activities                                       |       | (4,247,838                                                                 | )          | — |   | (4,247,838 | ) |
|                                                                         |       |                                                                       |       |   |   |   |   |
| Cash flows from  financing activities:                                       |       |                                                                       |       |   |   |   |   |
| Borrowings                                                                   |       | (208,986                                                                   | )          | — |   | (208,986 | ) |
| Repayments of  borrowings                                                    |       | 2,398,280                                                                  |       | — |   | 2,398,280 |   |
| Proceeds from  exercise of warrants, net                                     |       | 31,917,213                                                                 |       | — |   | 31,917,213 |   |
| Proceeds from  sale of common stock, net                                     |       | 34,106,507                                                                 |       | — |   | 34,106,507 |   |
|                                                                         |       |                                                                       |       |   |   |   |   |
| Net decrease in  cash and cash equivalents                                   |       | 26,691,721                                                                 |       | — |   | 26,691,721 |   |
| Cash and cash  equivalents at beginning of period                            |       | 4,014,191                                                                  |       | — |   | 4,014,191 |   |
| Cash and cash  equivalents at end of period                                  |       | $                                                                          | 30,705,912 |   | $ | — |   | $ | 30,705,912 |   |

 

**Note3 — Value Added Tax Receivable**

Value-addedtax (referred to as “IGV” in Peru) is generally imposed on goods and servicesat a rate of 19%. Peru currently has an early recovery system for explorationcompanies. Under this regime, IGV paid on the acquisition of goods and servicesused directly in hydrocarbon exploration activities can be recovered withouthaving to wait until a commercial discovery takes place or production begins.The Company has applied for early recovery of IGV paid since it does notanticipate first sales of power to the Peruvian power market until 2007.  During the third quarter of 2006 the Companyreceived a refund of approximately $1.5 million under the IGV early recovery program.  The Company’s value added tax receivablebalance as of September 30, 2006 was $1,420,763.

**Note4 — Inventories**

Inventories consist primarily of tubular goods andspare parts for production equipment, stated at the lower of cost or market.

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**Note5 — Prepaid and Other Current Assets**

Below is a summary ofprepaid and other current assets as of September 30, 2006 and December 31,2005:
| ** **                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2006**               | ** ** | **2005**              | ** ** |
|                              |       |                   |       |                  |       |
| Prepaid expenses  and other       |       | $                      | 1,549,778  |                  | $          | 270,903 |   |
| Deposits                          |       | 67,380                 |       | 181,347               |       |
| Interest  receivable              |       | 48,191                 |       | 54,864                |       |
| Prepaid and  other current assets |       | $                      | 1,665,349  |                  | $          | 507,114 |   |

 

Prepaidexpenses and other consist primarily of insurance premiums related to theCompany’s operations.

**Note 6 —Property, Equipment and Construction in Progress**

Below is a summary of property, equipment and construction in progress as of September 30, 2006 and December 31, 2005:
| ** **                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | **2006**               | ** ** | **2005**              | ** ** |
|                                                    |       |                   |       |                  |       |
| Construction in  progress:                              |       |                   |       |                  |       |
| Power plant and related equipment                       |       | $                      | 2,793,275  |                  | $          | 2,252,413 |   |
| Platforms and wells                                     |       | 11,449,412             |       | 1,190,707             |       |
| Pipelines and processing facilities                     |       | 1,669,470              |       | 512,357               |       |
| Barge and  related equipment                            |       | 6,487,080              |       | —                |       |
| Office  equipment, leasehold improvements, and vehicles |       | 890,078                |       | 439,359               |       |
| Accumulated  depreciation and amortization              |       | (188,033               | )          | (29,796               | )          |
| Net property,  equipment and construction in progress   |       | $                      | 23,101,282 |                  | $          | 4,365,040 |   |

 

Asof September 30, 2006, the Company incurred costs associated with itsdevelopment initiatives for the exploration and production of natural gas reservesand the complementary development of proprietary gas-fired power generation forsale in Peru.  The costs relate to theinitial engineering design work for the power plant, gas processing facilityand pipelines, modernization and refurbishment costs of the platform tenderassist drilling rig, and acquisition and refurbishment of one of the Company’soffshore platforms located in Block Z-1, as well as the purchase of a deckbarge and related equipment. In addition, during the third quarter 2006,approximately $275,000 has been incurred for recovery and temporary repairs tothe deck barge resulting from a navigation incident which caused the BPZ-01barge to be grounded on a sand bank in Talara Bay in northwest Peru during thesecond mobilization trip to the Corvina platform. See Note 10 to theConsolidated Financial Statements included in this filing, for additionaldiscussion regarding the barge incident. The Company also incurred costs foroffice equipment and leasehold improvements for its offices in Houston, Peruand Ecuador as well as for vehicles used in its Peruvian operations.

**Note 7 —Restricted Cash and Performance Bonds**

Inconnection with its properties in Peru, the Company has obtained threeperformance bonds totaling $2,650,000 to guarantee certain obligations andcommitments.  As of September 30,2006, BPZ had restricted cash deposits of $2,461,934 ($11,934 representsinterest earned), which collateralizes the performance bonds.  In addition to the cash collateral posted byBPZ, an individual shareholder of the Company provided a guarantee in theamount of $200,000 to the financial institution that issued one of the bonds tosecure the Company’s performance.  Theperformance bonds were issued by Peruvian banks and their terms are governed bythe corresponding license contract or agreement.

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**Note8 — Investment in Ecuador Property**

The Company has an investment in anoil and gas property in Ecuador (the “Santa Elena Property”) totaling$1,804,500 and $1,945,188 as of September 30, 2006 and December 31, 2005,respectively.  The Company accounts forthis investment under the cost method and records its share of cash received orpaid 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 amortization expense of $46,896 and $140,688 for the threeand nine months ended September 30, 2006, respectively, compared to$46,896 and $89,656 in the comparable periods of 2005.

**Note9 — Stockholders’ Equity**

TheCompany has 25,000,000 shares of preferred stock, no par value and 250,000,000shares of common stock, no par value, authorized for issuance.

**Private Placements of Common Stock**

OnJuly 19, 2005, the Company completed a private placement of 11,466,000shares of common stock, no par value, pursuant to a Stock PurchaseAgreement.  The common stock was pricedat $3.00 per share, resulting in net proceeds to the Company of$31,917,214.  In connection with theprivate placement, the Company was obligated to prepare and file with the SEC aRegistration Statement on Form S-1 and to use its best efforts to causethe Registration Statement to be declared effective by the SEC no later thanninety days from July 19, 2005. The Registration Statement was notdeclared effective by the required date and the Company became liable to theinvestors for liquidated damages in an amount equal to 1.0% of the purchaseprice of the shares, approximately $343,980, for each thirty day period untilthe Registration Statement is declared effective by the SEC. Certain of theprivate placement investors, totaling 76% of the aggregate investment, haveagreed to accept common stock in lieu of cash. Accordingly, 262,471 and 689,550 shares of common stock were issuedduring the three and nine months ended September 30, 2006, respectively to thosecertain investors for liquidated damages.

OnMarch 10, 2006 the Company completed a private placement of 1,670,000 shares ofcommon stock, no par value, to four institutional and accredited investorspursuant to a Stock Purchase Agreement. The common stock was priced at $3.00per share resulting in proceeds to the Company of $5,010,000.  In connection with the private placement, theCompany was obligated to prepare and file with the SEC a Registration Statementon Form S-1 within sixty days, and to use its best efforts to cause theRegistration Statement to be declared effective by the SEC no later than ninetydays, from March 8, 2006.  TheRegistration Statement was not filed or declared effective by the requireddates and the Company became liable to the investors for liquidated damages inan amount equal to 1.0% of the purchase price of the shares, approximately$50,100, for each thirty day period until the Registration Statement isdeclared effective by the SEC. These liquidated damages are payable, at thesole discretion of the Company, by cash or by the issuance of Company commonstock.  Accordingly, 51,123 shares and73,634 shares of common stock were issued during the three and nine monthsended September 30, 2006, respectively, to those investors for liquidateddamages.

On June 30, 2006, the Company completed a private placement of common stock for proceeds of $12,325,500 which were received in July 2006.  The Company sold 4,482,000 shares to eight institutional and accredited investors at a price of $2.75 per share.  There were no warrants or dilutive securities issued to the investors in connection with the offering.  The offering was placed directly by the Company and there were no placement fees.  The Company did, however, issue warrants to purchase 150,000 shares of the Company’s common stock to Morgan Keegan & Company, Inc. in consideration for their financial advisory services relating to the private placement.  In connection with the private placement, the Company was obligated to prepare and file with the SEC a Registration Statement on Form S-1 and to use its best efforts to cause the Registration Statement to be declared effective by the SEC no later than 150 days after June 30, 2006.

On November 8, 2006, the SEC declared effective the Registration Statement on Form S-1 covering the common shares issued in connection with the July 19, 2005, March 10, 2006, and June 30, 2006, private placements.  As a result, the Company is no longer subject to the liquidated damages described above.

**Stock Subscription Receivable**

During 2004, the Company issued 236,528 shares to an individual investor for $119,175 of cash proceeds and a subscription receivable of $230,825.  On behalf of the Company, the investor has pledged assets to a Peruvian bank in the 

17

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amount off $200,000, which pledge partially secures one of the Company’s performance bonds.  The subscription receivable is due at such time as the Company obtains its own performance bond to replace the one posted by the investor or until the performance bond is no longer required.

**Potentially Dilutive Securities**

In addition to its shares issued and outstanding, the Company has the following potentially dilutive securities as of September 30, 2006 and December 31, 2005.  None of these potentially dilutive shares have been included in the calculation of earnings per share as the effect would be anti-dilutive.

|                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                    | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Stock options  outstanding                                                    |       | 4,083,652              |       | 2,878,652             |       |
| Warrants  outstanding                                                         |       | 250,000                |       | 100,000               |       |
| Shares issuable  to consultant for services                                   |       | —                 |       | 10,000                |       |
| Contingent  incentive earn-out shares                                         |       | 260,000                |       | 485,000               |       |
| Contingent  Merger earn-out shares                                            |       | 9,000,000              |       | 9,000,000             |       |
|                                                                          |       |                   |       |                  |       |
| Total potentially dilutive securities                                         |       | 13,593,652             |       | 12,473,652            |       |
|                                                                          |       |                   |       |                  |       |
| Shares available for  grant pursuant to Long-Term Incentive Compensation Plan |       | 1,600,000              |       | 2,880,000             |       |

 

**Stock Options Outstanding**

Inconnection with the Merger, BPZ, as the accounting acquirer, assumed all Navidec stock options outstanding, which werefully vested on the date of the Merger and expire on September 10,2007.  Exercise prices on these stock options range from $1.30 to $1.93 pershare.  Under the terms of the Mergeragreement, NFS is entitled to receive all proceeds from the exercise of theseoptions.  As of December 31, 2005, therewere 653,652 Navidec stock options were outstanding.  During the nine month period endedSeptember 30, 2006, 275,000 Navidec stock options were exercised and 378,652 stock options remain outstanding.

In connection with theMerger, BPZ also issued options to purchase 1,500,000 shares of common stock atan exercise price of $2.00 per share to NFS. Such options were due to expire onJuly 31, 2006. However, on May 19, 2006, the Company entered into aSettlement Agreement and Mutual Release (the “ Settlement Agreement”) by andamong the Company, NFS and John McKowen, the Chief Executive Officer of NFS andformer Chief Executive Officer and Director of the Company (collectively, the “Parties”).  Among other things, the agreement extendedthe vesting period for NFS’s options. The Company agreed to extend the date forvesting in the remaining stock options from July 31, 2006, to one yearfollowing the effective date of the registration with the SEC of the shares NFSreceived in the Merger with Navidec, which as of the date of this filing, havenot yet been registered.  Subsequent tothe Merger, NFS conveyed 540,000 of such options to third parties. During 2005,275,000 options had been exercised, resulting in net proceeds to the Company of$550,000. As of September 30, 2006 1,225,000 of such options remainedoutstanding, of which 810,000 were held by NFS.

Additionally,the Company granted options to purchase 1,000,000 shares of common stock at anexercise price of $1.30 per share to the former CEO of Navidec in connectionwith his service as a director and financial consultant to the Company.  On the date of the Merger, 500,000 of suchstock options became fully vested.  Vestingof the remaining 500,000 stock options is contingent upon the receipt ofadditional investment proceeds totaling $6 million, including proceeds from theexercise of outstanding warrants.  Underthe Settlement Agreement, among other things, the Company agreed to extend thedate for vesting in the remaining 500,000 stock options from September 10,2006, to one year following the effective date of the registration with the SECof the shares NFS received in the Merger with Navidec, which as of the date ofthis filing, have not yet been registered. The Company further agreed that as of the date hereof, Mr. McKowen hasraised $5,935,000 towards the required $6,000,000, mentioned above, as acondition for fully vesting of the additional 500,000 options.  These stock options, when vested, will expire10 years from the date of grant. They were recorded at a fair value of $1.20per share using the Black-Scholes model. The unvested options are beingamortized over the original 24-month vesting period at the rate of $25,000 permonth unless the Company concludes such options are no longer probable of vesting.

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As of September 30, 2006,1,480,000 stock options have been granted under the Company’s 2005 Long-TermIncentive Plan. Options generally vest over a 2 – 3 year period. The exerciseprice of the options can not be less than the fair market value per share ofthe Company’s common stock on the grant date. These stock options, when vested, will expire 10 years from the date ofgrant. They were recorded at a weighted average fair value of $2.22 per shareusing the Black-Scholes model. The unvested options are being amortized over aweighted average vesting period of 1.6 years. None of these options have vested as of September 30, 2006.

All of the above stock options were recorded at fairmarket value.  Accordingly, no disclosureof pro forma results of operations under SFAS 123(R) is required.

**WarrantsOutstanding**

For their role asplacement agent, in connection with the private placement of 11,466,000 sharesof 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 onJuly 19, 2010. These warrants were valued at $325,000 using theBlack-Scholes model, which amount was treated as additional non-cash stockoffering costs.

Additionally, for theirfinancial advisory services, in connection with the private placement of4,482,000 shares of common stock in June 2006, Morgan Keegan &Company, Inc., received fully vested warrants to purchase 150,000 sharesof the Company’s common stock at an exercise price of $3.00 per share. Suchwarrants expire on June 30, 2011. These warrants were valued at $248,645 usingthe Black-Scholes model, which amount was treated as additional non-cash stockoffering costs.

**ContingentIncentive Earn-Out Shares**

During 2005, the Company’sBoard of Directors awarded a total of 485,000 shares of incentive stock awardsto three of the Company’s officers. The incentive stock awards vest and theearn-out shares are issuable once the Company is entitled to receive as itsproportionate share from gross production from any oil and gas wells owned oroperated 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 toDecember 28, 2007, the same target applicable to the Merger earn-outshares (see below). The total future stock-based compensation expenseassociated with these contingent incentive stock awards is $2,134,000 of which$559,862 and $441,517 correspond to the nine months ending September 30, 2006and twelve months ending December 31, 2005, respectively. Since the Company hasnot yet obtained a firm financing commitment for its gas-to-power project, theCompany does not consider the achievement of this target to be probable foraccounting purposes and is not currently accruing the associated stock-basedcompensation expense.  However, one ofthe Company’s officers resigned from the Company and its subsidiaries effectiveJune 15, 2006, and as a result 225,000 of the unvested contingent incentivestock awards, representing $990,000 of future possible compensation expense,were forfeited.

**MergerEarn-Out Shares**

Under the terms of theMerger Agreement, the Company committed to issue 18,000,000 shares to theformer shareholders of BPZ-Texas on a contingent earn-out basis if the Companyachieves certain reserve and production goals. The first earn-out targetrelating to reserves was achieved in December 2004 and 9,000,000 of theearn-out shares were issued. The remaining 9,000,000 earn-out shares areissuable once the Company is entitled to receive as its proportionate sharefrom gross production from any oil and gas wells owned or operated by theCompany not less than 2,000 barrels of oil per day or its equivalent(approximately 12 million cubic feet of gas per day) prior to December 28,2007.

For accounting purposes,the earn-out arrangement is treated as a stock dividend because the earn-out ispayable to the shareholders of the accounting acquirer, BPZ-Texas. Accordingly,except for a retroactive increase in the number of common shares outstandingfor all periods presented, no accounting entry is required upon the issuance ofthe earn-out shares.

**Long-Term Incentive Compensation Plan**

The BPZ Energy, Inc.2005 Long-Term Incentive Compensation Plan (the “LTIP” or “Plan”) permits theBoard of Directors to award eligible employees, directors and consultants withincentive-based and non-incentive-based compensation. The maximum number ofshares of stock of the Company that may be subject to incentives under thePlan, including without 

19

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limitation incentive options, is 4,000,000 shares, andsuch shares shall be reserved at all times until issued under the Plan. Of suchamount, no more than 1,600,000 shares in the aggregate shall be eligible forthe issuance of performance shares, stock grants, restricted stock grants andother stock-based incentives. The LTIP will be administered and managed withinthe discretion of compensation committee of the Company or, in the absence ofsuch committee, by the Board of Directors. Incentives under the LTIP may begranted to eligible employees, directors or consultants in any one or acombination of incentive options, non-statutory stock options, stockappreciation rights, restricted stock grants, stock grants and performanceshares. As of September 30, 2006, there were 1,600,000 shares available to begranted by the Company under the LTIP.

**Note10 — Commitments and Contingencies**

*Barge Incident*

Inearly August 2006, the Company incurred an operational delay of approximatelythree weeks resulting from a navigation incident which caused the BPZ-01 bargeto be grounded on a sand bank in Talara Bay in northwest Peru during the secondmobilization trip to the Corvina platform. No injuries were sustained by any ofthe Company’s staff, nor to any of the tug boat operator’s crew members. TheBPZ-01 is a U.S. flagged vessel and as such was inspected after the incident bythe U.S. Coast Guard, to its satisfaction. The barge resumed normal operationsimmediately thereafter. Based upon information currently available, the Companyestimates that total expenditures related to this incident will beapproximately $1.1 million. As of September 30, 2006, approximately$275,000 has been incurred for barge recovery and temporary repairs to thevessel.  In addition, the Company expectsto incur approximately $400,000 in permanent repairs to the barge andapproximately $425,000 of consequential damages, primarily stand-bycharges.  As of the date of this filing,the Company has not presented a final claim to its insurance carrier for thebarge repairs and is negotiating a settlement agreement with the third party involvedin the accident for recovery of any damages not covered through its insurance.  The Company believes the majority of thecosts associated with this incident will be reimbursed through insurance orthrough a third party. No assurances can be given, however, that any suchrecoveries will be sufficient to cover all costs associated with this incidentor to the timing of any such recoveries. This incident is not expected to havea material impact on the Company’s operations or business plan.

*Transfer of NFS*

On September 9, 2004, theday prior to the effective date of the Merger, Navidec assigned all of itspre-merger business operations, assets and liabilities to NFS and all issuedand outstanding shares of NFS were subsequently transferred to the Navidecpre-merger shareholders of record as of September 9, 2004, for no cashconsideration.

The transfer of NFSshares was effected by NFS to the pre-merger Navidec shareholders of record asof September 9, 2004. Consistent with the terms of the Merger Agreement, theCompany had no control in the actions resulting in the transfer of the NFS sharesand the Company believed, based on information provided by NFS and its advisorsthat NFS had undertaken the necessary actions to comply with applicableregistration requirements. However, because a registration of the NFS shareswas not effective at the time of the transfer of the NFS shares, and has stillnot become effective, it might be determined that the transfer of the NFSshares was made without full compliance with registration or qualificationrequirements under applicable securities laws. As a result, although theCompany took no actions in connection with the transfer, because the Company isa successor by merger to Navidec, Inc., if regulatory authorities determinethat the Company did not comply with applicable registration requirements in connectionwith the transfers, fines or other sanctions could be imposed on the Companywith respect to the transaction.

While federal and stateregulators might conclude that the Company was subject to responsibility forregistration of the shares, the Company regards the possibility of liabilityarising from the distribution of the NFS shares as remote for the followingreasons:

The Company took noaction with respect to the transfer of NFS shares which, pursuant to the termsof the Merger Agreement, was agreed to be handled by NFS, including anynecessary qualifications or registrations under applicable securities laws.Further, the Company believed, based on information provided by NFS and itsadvisors, that NFS had undertaken to comply with all applicable registrationrequirements. Additionally, the transfer, which was tantamount to a stockdividend to the pre-merger shareholders of Navidec, Inc., did not involve cashconsideration, making a finding of any damage to shareholders unlikely.Finally, it is the Company’s understanding that NFS is taking action toregister the NFS shares and is communicating with the SEC to address this issueto the SEC’s satisfaction.

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Although the Companyregards the possibility of liability resulting from the transfer of NFS asremote, the Company does recognize the risk of such liability, and thereforecautions current and prospective Company shareholders of such risk.

*Peru Properties*

The Company has variousobligations and commitments in connection with its properties in Peru. Inconnection with its Block Z-1 property, the Company posted a $1,300,000performance bond in January 2005. To satisfy its current performanceobligation under the second exploration phase of the Block Z-1 licenseagreement, the Company must drill at least one well or acquire a specifiedamount of seismic data prior to July 2007. The Company is in the processof satisfying  its obligation by drillinga well which is currently budgeted to cost approximately $6,000,000. Inaddition, in connection with its Block XIX property, the Company posted a$350,000 performance bond in August 2005. To satisfy its currentperformance obligation under the second exploration phase of the Block XIXlicense agreement, which began in August 2005 and will last for 24 months,the Company plans to shoot approximately 100 kilometers of 2-D seismic dataduring the first half of 2007 which is budgeted to cost approximately $2million.  In addition, based on theresults of the seismic data, the Company plans to prepare an integratedgeological, geochemical and reservoir engineering evaluation of hydrocarbonprospects to define the subsequent wildcat drilling.

The Company acquired fouroffshore platforms in connection with its Block Z-1 property. The Companyrecently completed the refurbishment of one of the offshore platforms andintends to maintain all of such platforms for use throughout the life of theBlock Z-1 contract. These platforms revert back to the Government of Peru atthe end of the contract, provided they are in good working condition, with nofurther obligation to the company to dismantle or remove them. The Company andits legal advisors have reviewed Peruvian law and existing regulations from thePeruvian Ministry of Energy and Mines in conjunction with the requirements ofFAS 143 “Accounting for Asset Retirement Obligations” (“ARO”) as it applies totangible long lived assets and their future retirement and dismantlement. TheCompany has concluded there is no legal obligation to dismantle the platforms,as defined in FAS 143, and therefore recognition of an ARO is not required.Accordingly, no such provision is reflected in the accompanying consolidatedfinancial statements. If, however, current laws or regulations were changed orthe platforms were no longer in good working order, the Company could beobligated to dismantle and remove them. The current estimated cost to dismantlean offshore platform is estimated to be approximately $2 million, dependingupon the condition of the platform and the depth of the water.

In December 2005,the Company signed a drilling contract with Petrex S.A., a subsidiary of SaipemSpA of Italy. Under the contract, Petrex S.A. will provide a platform rigcapable of drilling to 16,000 feet and upgrade the rig to meet the Company’sspecifications. The Company intends to utilize the rig for the initialdevelopment of the Corvina gas field and may also utilize it for the expecteddevelopment of the Albacora oil field, and potential appraisal wells in thePiedra Redonda gas field. The Company has agreed to pay a $5.5 million fee tomobilize and upgrade the rig. In exchange, the Company will receive acompetitive fixed day rate and exclusive rights to use the rig, at its option,during the two-year period commencing in September, 2006.

In December 2005,the Company notified Perupetro that it had decided to exercise its exclusiveoption to convert its Technical Evaluation Agreement on Area VI, into a licensecontract.  The new area has been renamedas Block XXII consisting of approximately 948,000 acres and will encompass asignificant portion of the Lancones basin. In connection with this block, after the license contract has been signed, theCompany will be required to post a performance bond to guarantee certainobligations and commitments. However, negotiations on the terms of the licensecontract are still underway and the Company has not been officially awarded thelicense contract.  Accordingly, theCompany does not have sufficient information to determine the timing, norestimate the value of the performance bond to be posted in connection with thisproperty.

In July 2006, Perupetro informedthe Company that its proposal for Block XXIII, which consists of approximately248,000 acres and is located onshore in northwest Peru between the Company’sBlocks Z-1 and XIX, was the winning bid in the tender process.  The Company is in the process of presentingall necessary documentation to become the qualified operator of this new blockand will then begin negotiation of the exploration and production licensecontract. The Company’s proposal covers only the exploration period and commitsthe Company to drill a certain number of wells, acquire certain amount ofeither 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 thisblock, after the license contract has been signed, the Company will be requiredto post a performance bond to guarantee certain obligations and commitments.However, the Company has not been officially awarded the license contract anddoes not have sufficient information to determine the timing, nor estimate thevalue of the performance bond to be posted in connection with this property.

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*Financing Activities*

On May 27, 2005, BPZsigned a Mandate Letter with the International Finance Corporation (“IFC”), amember of the World Bank Group based in Washington, D.C., to facilitate thefinancing of the Company’s initial capital expenditure program in Block Z-1 innorthwest Peru. On November 1, 2005, an amendment was signed extending theoriginal term of the Mandate Letter from December 31, 2005 toAugust 31, 2006. On August 29, 2006, an amendment was signed extending theoriginal term of the Mandate Letter from August 31, 2006 to November 30,2006. The Mandate Letter specifies that IFC will appraise BPZ’s project in Peruto determine the feasibility and structure of a potential financingtransaction. Any IFC investment will depend on the project and the Companymeeting IFC’s financing criteria, the overall financing plan being acceptableto IFC, approval of the investment by management and the Board of IFC, and theexecution of all appropriate documentation, in form and substance satisfactoryto IFC. As part of the Mandate, BPZ agreed to pay total fees of $285,000 duringthe appraisal period and customary expenses. As of September 30, 2006,$85,000 of fees and approximately $71,900 of reimbursable out-of-pocketexpenses had been incurred.

In connection with the July 19, 2005 private placement of 11,466,000 common shares, the Company was obligated to prepare and file with the SEC a Registration Statement on Form S-1 and to use its best efforts to cause the Registration Statement to be declared effective by the SEC no later than ninety days from July 19, 2005. The Registration Statement was not declared effective by the required date and the Company became liable to the investors for liquidated damages in an amount equal to 1.0% of the purchase price of the shares, approximately $343,980, for each thirty day period until the Registration Statement is declared effective by the SEC. Certain of the private placement investors, totaling 79% of the aggregate private placement investment, agreed to accept common stock in lieu of cash for a maximum period of 90 days. The 90-day period ended on February 14, 2006 and the Company began paying the full amount of liquidating damages in cash.  A new agreement was entered into on April, 17 2006 with certain private placement investors, totaling 76% of the aggregate  private placement investment to accept common stock in lieu of cash until the Registration Statement on Form S-1 is declared effective by the SEC. As of September 30, 2006, the Company’s Registration Statement on Form S-1 had not been declared effective by the SEC and Company continued to be liable to the investors for the aforementioned liquidated damages.  On November 8, 2006, the SEC declared effective the Registration Statement on Form S-1 covering the common shares issued in connection with the July 19, 2005, March 10, 2006, and June 30, 2006, private placements.  As a result, the Company is no longer subject to the liquidated damages described above.

In connection with the March 10, 2006 private placement of 1,670,000 common shares, the Company was obligated to prepare and file with the SEC a Registration Statement on Form S-1 and to use its best efforts to cause the Registration Statement to be declared effective by the SEC no later than ninety days, from March 8, 2006.  The Registration Statement was not declared effective by the required date and the Company became liable to the investors for liquidated damages in an amount equal to 1.0% of the purchase price of the shares, approximately $50,100, for each thirty day period until the Registration Statement is declared effective by the SEC.  Such liquidated damages are payable in common stock or cash at the Company’s discretion.  As of September 30, 2006, the Company’s Registration Statement on Form S-1 had not been declared effective by the SEC and Company continued to be liable to the investors for the aforementioned liquidated damages.  On November 8, 2006, the SEC declared effective the Registration Statement on Form S-1 covering the common shares issued in connection with the July 19, 2005, March 10, 2006, and June 30, 2006, private placements.  As a result, the Company is no longer subject to the liquidated damages described above.

The Company will continueto make commitments in the ordinary course of business as it pursues itsdevelopment plans for the properties.

**Note11 — Legal Proceedings**

*SEC Inquiry of Navidec*

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

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In December 2004, theCompany received notice that the SEC had issued an Order Directing a PrivateInvestigation and Designating Officers to Take Testimony and would beconducting a formal investigation. BPZ has cooperated fully with the SEC inthis matter. As of December 31, 2005, a total of approximately $50,000,primarily in legal fees, had been incurred in connection with the SECinvestigation. Pursuant to the Merger Agreement, the Company has beenindemnified by NFS for the costs of the SEC investigation and NFS has borne thecosts incurred to date. BPZ is not aware of additional actions, if any, the SECintends to pursue in this matter, but no assurance can be given that theinvestigation will be resolved without negative consequences to the Company.

*Transfer of Ownership in NFS*

On July 8, 2004, Navidecand BPZ-Texas entered into a Merger Agreement which was consummated onSeptember 10, 2004. The Merger Agreement provided that all of the pre-mergerbusiness operations, assets and liabilities of Navidec would be transferred toa wholly-owned subsidiary, Navidec Financial Services, Inc., followed by thetransfer of NFS to the pre-merger shareholders of record as of September 9,2004, the day prior to the consummation of the Merger. See Note 2 to theConsolidated Financial Statements, included in this filing, for detaileddiscussion regarding the Merger.

The Merger Agreementprovided that the transfer of all of the pre-merger business operations, assetsand liabilities to NFS was effective as of September 9, 2004. Accordingly, theCompany originally believed that it had no continuing ownership of NFS and,therefore, did not account for the post-merger operations of NFS in thepresentation of its financial statements. After receipt of comments from theSEC in connection with its review of the Company’s registration statement onForm SB-2 originally filed on July 27, 2005 and further review of this issue,the Company concluded it was the record, but not beneficial, owner of NFSshares, and that any ownership interest was at most temporary. The Companytherefore decided to restate its financial statements to more accuratelyreflect the impact of its temporary ownership of NFS on the equity method.However, the SEC continued to comment on the accounting presentation of theCompany’s ownership of NFS.

In part because ofdifficulty obtaining necessary information from NFS to clarify the ownershipissue, the Company commenced an action against NFS (the “Action”) on or aboutFebruary 13, 2006, in District Court, Arapahoe County, Colorado, seekingdissolution of NFS, the appointment of a receiver, and access to NFS corporaterecords. The Company commenced the Action uncertain whether or when therequired spin-off of NFS shares pursuant to the terms and conditions of theMerger had occurred under Colorado corporate law. The Company asserted in theAction that it believed it was a record shareholder of NFS as of the date ofthe request and had standing for the relief sought. NFS denied that the Companyhad standing to act as a shareholder and asserted that the Company had not beena shareholder of NFS since September 9, 2004. A Findings of Fact andConclusions of Law issued by the Court determined that the Company was not ashareholder of NFS at any time after September 9, 2004.

**Note 12 — Subsequent Events**

On November 8, 2006, the SEC declared effective the Registration Statement on Form S-1 covering the common shares issued in connection with the July 19, 2005, March 10, 2006, and June 30, 2006, private placements.  As a result, the Company is no longer subject to the liquidated damages described in Notes 9 and 10.

**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

**Business**

BPZEnergy, Inc., a Colorado corporation, formerly named Navidec, Inc., wasincorporated in 1993 and is based in Houston, Texas.  We are an exploratory stage company focusedon the exploration and production of oil and natural gas and the complementarydevelopment of gas-fired power generation.

OnSeptember 10, 2004, BPZ Energy, Inc., a Texas corporation,consummated a reverse merger with Navidec, Inc. whereby BPZ-Texas became awholly owned subsidiary of Navidec. However, in the Merger, the stockholder group of BPZ-Texas obtainedmajority ownership and management control of the combined company.  The Merger was treated, for accountingpurposes, as a capital transaction rather than a business combination.  It is equivalent to the issuance of commonstock by BPZ-Texas for the net assets of Navidec, accompanied by arecapitalization.  This accountingtreatment is identical 

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to that resultingfrom a reverse merger under SFAS 141, except that no goodwill or otherintangible asset has been recorded.  OnFebruary 4, 2005, we changed our name from Navidec, Inc. to BPZEnergy, Inc.  Although our name hasbeen changed, the pre-merger company may be referred to as Navidec in thisfiling, as the context may require, to avoid confusion.

The Merger Agreementprovided that all of the pre-merger business operations, assets and liabilitiesof Navidec would be transferred to a wholly owned subsidiary, NFS, followed bythe transfer of ownership of NFS to the shareholders of record as ofSeptember 9, 2004, the day prior to the consummation of the Merger.  Accordingly, the pre-merger shareholders ofBPZ-Texas were not entitled to receive shares of NFS.  Upon consummation of the Merger, we becamecontractually and irrevocably bound to the spin-off of NFS to such pre-mergershareholders.  All legal requirements forthe transfer of ownership of NFS have been completed except for registration ofthe NFS shares with the Securities and Exchange Commission and the finaldistribution of NFS common shares to the pre-merger shareholders of theCompany.  We have no control over theregistration process of NFS and cannot predict when, or if, the management ofNFS will be able to complete the registration of NFS common shares.  NFS’ results are excluded from the Company’sfinancial statements for all periods presented.

Wemaintain a registered branch office in Peru. Currently, we have exclusive rights and license agreements for oil andgas exploration and production covering a total of approximately 2.4 millionacres in northwest Peru.  Our licensecontracts cover 100% ownership of both Block Z-1 (739,205 acres), which wassigned in November 2001 and Block XIX (472,860 acres), which was signed inDecember 2003. Our license contracts provide for an initial explorationperiod of seven to thirteen years and seven to ten years, respectively andrequire that we conduct specified activities on the properties during thisperiod.  If our exploration activitiesare successful, the total contract term may be extended up to 30 years for oilexploration and production and up to 40 years for gas exploration andproduction.  We have presented allnecessary documentation requested by Perupetro in order to become the qualifiedoperator under a license contract for Block XXII (948,000 acres) which wepreviously held under a Technical Evaluation Agreement and was referred to asArea VI in our previous filings.  In July 2006, Perupetroofficially informed us that our proposal for the 248,000 acre Block XXIII,located onshore in northwest Peru between our Blocks Z-1 and XIX, was the winningbid in its recent tender process.  Wehave presented all necessary documentation to become the qualified operator ofthis new block under  an exploration andproduction license contract.

Throughour wholly owned subsidiary, SMC Ecuador Inc. (a Delaware corporation), and itsregistered branch in Ecuador, we also own a 10% non-operating working interestin an oil and gas producing property, Block 2, located in the southwest regionof Ecuador (the “Santa Elena Property”). The license agreement covering the property extends throughMay 2016.

Weare in the exploratory stage and to date our activities in Peru have beenlimited to analysis and evaluation of technical data on the properties andpreparation of the development plans for the properties, including detailedengineering and design of the power plant and gas processing facilities,refurbishment of one of our offshore platforms, procuring machinery andequipment for our drilling campaign, obtaining all necessary environmental andoperating permits, and securing the required capital and financing to completeour current plan of operation. We began drilling operations on our first wellin September, 2006.  We do not anticipategenerating significant revenues from our properties prior to the fourth quarterof 2007.

**Results of Operations**

Our operating and administrativeexpenses to date have consisted principally of general and administrative costsas well as geological, geophysical and engineering costs.  General and administrative costs have increasedsignificantly from $900,136 during the third quarter of 2005 and $2,785,122during the nine months ended September 30, 2005 to $2,373,475 during thesecond quarter of 2006 and $5,813,311 during the nine months endedSeptember 30, 2006 as a result of our increased activity levels,additional personnel and costs associated with being a public company.  We incurred $638,505 of geological,geophysical and engineering costs in the third quarter of 2006 and $1,502,212during the nine months ended September 30, 2006 primarily related to thecommencement of our Block Z-1 gas-to-power project, compared to $98,854 and$528,045 in the comparable periods of 2005.

Stock-basedcompensation expense for the three and nine months ended September 30, 2006 wasapproximately $879,877 and $2,229,970, respectively, compared to $526,000 and$780,270 during the same respective periods in 2005.  Stock based compensation expense is primarilyrelated to our 2005 and 2006 restricted stock grants and accrued stock-basedcompensation under our 2005 Long-Term Incentive Plan.

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We received net cash distributionsfrom our Ecuador property of $442,113 and $1,123,763 during the three monthsand nine months ended September 30, 2006, respectively, compared to netcash distributions of $188,524 and $393,713 during the three and nine monthsended September 30, 2005, respectively. 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, we recorded $46,896 and $140,688of amortization expense during the three months and nine months endedSeptember 30, 2006, respectively, compared to $46,896 and $89,656 duringthe three and nine months ended September 30, 2005.

We incurred interest expense of$27,007and $29,845 during the three and nine months ending September 30, 2006,respectively, primarily related to other debt as compared with interest expenseof $388 and $8,355 and amortization of deferred financing costs of $9,652 and$67,562 for the three and nine months ended September 30, 2005, respectively,principally from notes payable incurred to finance the acquisition of SMC inSeptember 2004.

For the three and nine months ended September 30, 2006, we recorded registration delay expense totaling $1,191,836 and $3,324,966, respectively, of which approximately $273,356 and $1,300,350 was paid in cash and $918,480 and $2,024,616 was paid by the issuance of 313,594 and 763,184 shares of common stock, respectively.  In connection with the private placement of 11,466,000 common shares in July 2005, we were obligated to prepare and file with the SEC a Registration Statement on Form S-1 and to use our best efforts to cause the Registration Statement to be declared effective by the SEC no later than ninety days from closing. The Registration Statement had not been declared effective by the required date and we were liable to the investors for liquidated damages in an amount equal to 1.0% of the purchase price of the shares, approximately $343,000, for each thirty day period until the Registration Statement is declared effective by the SEC. In addition, in connection with the private placement of 4,482,000 common shares in March 2006, the Company was obligated to prepare and file with the SEC a Registration Statement on Form S-1 within ninety days, and to use its best efforts to cause the Registration Statement to be declared effective by the SEC no later than ninety days, from March 8, 2006.  The Registration Statement was not filed or declared effective by the required dates and we were liable to the investors for liquidated damages in an amount equal to 1.0% of the purchase price of the shares, approximately $50,010, for each thirty day period until the Registration Statement is declared effective by the SEC.  On November 8, 2006, the SEC declared effective the Registration Statement on Form S-1 covering the common shares issued in connection with the July 19, 2005, March 10, 2006, and June 30, 2006, private placements.  As a result, the Company is no longer subject to the liquidated damages described above.

As a result of the increased cashbalance from the various private placements of our common stock during 2005 and2006, we received interest income of $216,525 and $644,558 during the three andnine months ended September 30, 2006, respectively as compared to $212,073for the three and nine month period ended September 30, 2005.

We realized a net loss of$4,563,806 or $0.10 per share, during the three months ended September 30,2006, compared to a net loss of $1,142,592, or $0.03 per share, for the sameperiod in 2005.  For the nine monthsended September 30, 2006, we realized a net loss of $11,442,285, or $0.26per share, as compared to a net loss of $3,603,609, or $0.12 per share, for thesame period in 2005.

**Plan of Operation**

Our current plan of operation isfocused primarily on exploiting the resource opportunities in the offshoreBlock Z-1 in northwest Peru, in which we own a 100% working interest.  Our initial project is the development of anintegrated gas-to-power project which is more fully described below.  The capital budget for our plan totalsapproximately $126.7 million. To achieve our objectives, we must obtainsignificant financing from external sources. We are attempting to securefinancing for the project, but we do not have firm commitments from externalsources to allow us to undertake all of the operations envisioned in this plan. See “Liquidity, Capital Resources and CapitalExpenditures,” below, for further discussion.

Our first priority is drilling theinitial gas wells in the Corvina Field to develop reserves and establish gasdeliverability at expected levels.  InDecember 2005, we signed a drilling contract with Petrex S.A., a subsidiaryof Saipem SpA of Italy. Under the contract, Petrex S.A. will provide a platformrig capable of drilling to 16,000 feet and upgrade the rig to meet ourspecifications.  We agreed to pay a $5.5million fee to mobilize and upgrade the rig. In exchange, we will receive a competitive fixed day rate and exclusiverights to use the rig, at our option, during the two-year period commencingwith delivery and final acceptance of the rig which occurred in September2006.  In addition, after the guaranteedtwo-year period, we have the option to extend the contract for an additionalyear at market rates.

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The Corvina Field has an existingplatform which has been refurbished.  The platform was evaluated as fit for operations by the independent riskmanagement consulting firm of ABSG Consulting, Inc. and is ready for drillingoperations. Accordingly, we commenced mobilization of the drilling rig to theCorvina platform in July 2006, and began drilling operations in September 2006.

In April 2006, we acquired and equipped a deck barge thatwill be used to transport the drilling rig to the Corvina platform and then actas a tender for drilling operations at Corvina, and our other properties.  The large deck barge is also adequate to hostproduction facilities.  The deck barge,officially named BPZ-01, is equipped with a 200 ton crane for loading andoff-loading.  BPZ-01 and relatedequipment, including a smaller 35 ton crane, two winches and related spareparts, were acquired for approximately $6.0 million.  BPZ-01 is an important element in the Company’sstrategy to control costs by allowing the use of existing platforms andavoiding the use of high priced drill ships or barges.

Our initial plans call for thedrilling of three new wells from the existing platform.  Our property also has a shut-in gas wellwhich we intend to recomplete and utilize for gas production.  We have secured all tubular goods to meet ourplanned needs for the first two gas wells of the initial three-well drillingcampaign.  We have obtained the requiredenvironmental and drilling permits in order to commence drillingoperations.  The Company spud its firstwell in the Corvina field in September 2006 and drilling to total depth isexpected to take approximately 60 days. The drilling of this first well at Corvina will satisfy our contractualexploration commitment under the current second exploration period of the BlockZ-1 License Contract.  Furtherdevelopment drilling from the existing platform, encompassing three additionalwells, is expected to be funded from project cash flows after the power plantis operational.

Our plan of operation envisions theinstallation of a Company-owned 160 megawatt (‘‘MW’’) gas-fired electricgeneration plant near the town of Caleta Cruz, in northwest Peru.  In August 2005, we awarded the turnkeycontract for the engineering, procurement and construction (EPC) of the powerplant project to BTEC Turbines LP of Houston (“BTEC”).  The contract was awarded following acomprehensive six month bidding process that included field visits by all ofthe bidders.  Under the EPC contract, thefinal terms of which are being negotiated, BTEC is expected to supply twoGeneral Electric Frame 7 simple-cycle gas-fired turbines.  BTEC will also act as the main contractor forthe design, transportation, construction, startup and commissioning of thepower plant.  Our plan is to own 100% ofthe power plant.  Accordingly, ourrevenues from the natural gas delivered to the power plant will be derived fromthe sale of electricity.

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

Primarily as a result of delays inobtaining a drilling rig, the projected goal for first sales of power to the Peruvianpower market isnow the fourth quarter of 2007.  Thistimeline is subject to many factors, including securing necessary financingcommitments, which are beyond our control. Based on the revised timeline, we intend to focus our capitalexpenditures on critical drilling activities. Procurement activities on other phases of the project will be delayed orrescheduled accordingly.  We believe wehave sufficient capital resources to fund our initial drilling program.  See “Liquidity,Capital Resources and Capital Expenditures” below for further discussion.

In addition to the local powermarket targeted by our project in Peru, we intend to simultaneously develop agas sales strategy in nearby Ecuador to capitalize on what we believe to besignificant upside gas potential of the Corvina and Piedra Redonda Fieldslocated in Block Z-1, as well as the potentially significant natural gasresources in the adjacent onshore Block XIX. These properties are in close proximity with the Ecuadorian border andcan be developed for export sales of either raw gas or power generation viaconnection to the transmission system of Ecuador.  Our initial plan of operation calls for us toconstruct a 40-mile pipeline from Caleta Cruz, the terminal point of ouroffshore pipeline from the Corvina Field, to Arenillas, Ecuador.  We intend to sell gas for the generation ofelectricity by third party power producers in the local market in Ecuador.  We have negotiated several preliminaryagreements for sales of gas.  We areplanning to complete this pipeline for first sales of gas to Ecuador in late2008, though this schedule is subject to many factors outside our controland no assurance can be given that we can meet this schedule.

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In addition to the initial CorvinaField development project, we have other fields within Block Z-1 and otherproperties which we intend to exploit in the future.  We recently completed our technicalevaluation of Area VI, now named Block XXII, and have initiated negotiations toobtain a license contract for exploration activities.  Block XXII is a large onshore block innorthwest Peru and encompasses a significant portion of the LanconesBasin.  In July 2006, Perupetroofficially informed us that our proposal for the 248,000 acre Block XXIII,located onshore in northwest Peru between our Blocks Z-1 and XIX, was thewinning bid in their tender process.  Weare in the process of presenting all necessary documentation to become the qualifiedoperator of this new block and will begin negotiating the exploration andproduction license contract thereafter. We have secured the environmental permits and otherauthorizations to shoot seismic in Block Z-1 and Block XIX.  We are seeking to obtain additional fundingfor these projects from industry or capital market sources, but we are notcurrently planning to make significant capital expenditures for seismicacquisition or other exploration and production activities outside the CorvinaField until we have secured such additional financing.

We are continuing to develop ourengineering plans and designs for the various components of our initial plan ofoperation.  We have paid in full or inpart for some components of our initial plan and have obtained cost estimatesfor most of the remaining major equipment components and the shipping,construction, installation and associated services.  However, the costs of these procurement andconstruction activities can be difficult to accurately predict and are subjectto change and contingencies.  Based onour current estimates, we expect our initial project, including the cost of thenatural gas pipeline to Arenillas, Ecuador, will require total capitalexpenditures on the order of $126.7 million, including import duties andcontingencies.  Our budget has increasedas a result of higher projected drilling costs due to the tight market for oiland gas drilling equipment, the acquisition of the deck barge, the selection oflarger capacity turbines and other significant cost increases in other industryrelated items such as insurance.  Thisestimate of capital expenditures does not include value added tax (referred toas “IGV” in Peru).  IGV is generallyimposed on goods and services at a rate of 19%. Certain expenditures are exempt from IGV or eligible for acceleratedrefund.  IGV paid on capital expendituresis generally recoverable from our future revenue billings within Peru and isnot considered part of the capitalized costs of the equipment to which it relates.  We may also be able to defer payment ofcertain of these expenditures or obtain separate financing for the IGV.

**ProjectCapital Budget**
|                                      | ** ** | **($ millions)** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| Power plant and  related equipment   |       | $                     | 53.2       |   |
| Pipelines and  processing facilities |       | 37.4                  |       |
| Platform and  wells                  |       | 30.7                  |       |
| Contingencies                        |       | 5.4                   |       |
| Total estimated  capital budget      |       | $                     | 126.7      |   |

 

**Liquidity, Capital Resources and CapitalExpenditures**

As of September 30, 2006, our cashbalance was approximately $16.7 million.

Ourinitial projectin the offshore Block Z-1 in northwest Peru, totaling approximately $126.7million, includes the refurbishment of the CX-11 platform,rehabilitation of an existing well and the drilling of three new wells,installation of a 10-mile gas pipeline from the platform to shore, constructionof a 160 MW simple-cycle electric generating plant, and the construction of a40-mile gas pipeline to supply gas to third party generators in Arenillas,Ecuador.

Inconnection with the Merger, we received net proceeds of approximately$5.5 million from a private placement of our common stock.  In July 2005, we completed a privateplacement of 11,466,000 shares of common stock for net proceeds ofapproximately $31.9 million.  MorganKeegan & Company, Inc. served as placement agent for theoffering.  We also received $3.4 millionfrom the exercise of warrants during the third and fourth quarters of2005.  In March 2006 and June 2006, wecompleted private placements of 1,670,000 shares and 4,482,000 shares of commonstock, respectively, for net proceeds of approximately $5.0 million and $12.3million, respectively.

InMay 2005, we signed a Mandate Letter with International FinanceCorporation (“IFC”), a member of the World Bank Group based in Washington,D.C.  The Mandate Letter specifies thatthe IFC will appraise our project in Peru to determine the feasibility andstructure of a potential financing of up to $100 million. The IFC’s appraisalof the project will include a review of the technical, economic, commercial,financial, environmental and legal aspects of the project. IFC’s 

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financing, thestructure of which would be defined during the appraisal process, will dependon the project and the Company meeting the IFC’s financing criteria, theoverall financing plan being acceptable to IFC, approval of the investment by managementand the Board of IFC, and the execution of all appropriate documentation, inform and substance satisfactory to IFC. As part of the Mandate, we have agreed to pay fees of $285,000 andcustomary expenses during the appraisal period. TheIFC is continuing its due diligence on the project.  In recognition of the revised drillingtimeline, the IFC recently extended the Mandate period to November 30, 2006 andis reviewing an increase in the total amount of the financing based on theincreased capital budget for the project.

Duringthe nine months ended September 30, 2006, we incurred capital expenditures ofapproximately $18,896,179 million primarily on the purchase of a deck barge andrelated equipment for approximately $6.5 million, modernization andrefurbishment costs of the platform tender assist drilling rig of approximately$10.3 million, continued work on the refurbishment of the Corvina platform andpower plant and gas processing facilities designs of approximately $1.7million, and $0.4 million on other miscellaneous property and equipment.  In addition, during the year endedDecember 31, 2005, we incurred capital expenditures of approximately $4.4million, primarily on refurbishment of the Corvina platform and power plantdesign costs.  As of September 30, 2006,in connection with our Peru properties, we have deposited approximately $2.5million as restricted cash to collateralize three performance bonds whichguarantee our various obligations and commitments under two of our licensecontracts and other agreements.  Theperformance bonds were issued by Peruvian banks and their terms are governed bythe corresponding license contract or agreement.

Inearly August 2006, the Company incurred an operational delay of approximatelythree weeks resulting from a navigation incident which caused the BPZ-01 bargeto be grounded on a sand bank in Talara Bay in northwest Peru during the secondmobilization trip to the Corvina platform. No injuries were sustained by any ofthe Company’s staff, nor to any of the tug boat operator’s crew members. TheBPZ-01 is a U.S. flagged vessel and as such was inspected after the incident bythe U.S. Coast Guard, to its satisfaction. The barge resumed normal operationsimmediately thereafter. Based upon information currently available, the Companyestimates that total expenditures related to this incident will beapproximately $1.1 million. As of September 30, 2006, approximately$275,000 has been incurred for barge recovery and temporary repairs to thevessel.  In addition, the Company expectsto incur approximately $400,000 in permanent repairs to the barge andapproximately $425,000 of consequential damages, primarily stand-bycharges.  As of the date of this filing,the Company has not presented a final claim to its insurance carrier for thebarge repairs and is negotiating a settlement agreement with the third party involvedin the incident for recovery of any damages not covered through itsinsurance.  The Company believes themajority of the costs associated with this incident will be reimbursed throughinsurance or through a third party. No assurances can be given, however, thatany such recoveries will be sufficient to cover all costs associated with thisincident or to the timing of any such recoveries. This incident is not expectedto have a material impact on the Company’s operations or business plan.

With our current cash balance andproceeds from the expected IFC financing, we believe we will have sufficientcapital resources to execute our initial project as we currently envisionit.  However, the timing andexecution of our project is dependent on a variety of factors, includingtechnical design of facilities, permitting, availability of equipment, time andcosts required for delivery and construction, performance by contractors andfinancing, many of which are outside our control.

**Off-Balance Sheet Arrangements**

As of September 30, 2006, wehad no transactions, agreements or other contractual arrangements withunconsolidated entities or financial partnerships, often referred to as specialpurpose entities, which generally are established for the purpose offacilitating off-balance sheet arrangements.

**Critical Accounting Policies and RecentAccounting Pronouncements**

The discussion and analysis of ourfinancial condition and results of operations is based on our consolidatedfinancial statements, which have been prepared in accordance with U.S.generally accepted accounting principles (“GAAP”).  Management uses estimates and assumptions inpreparing the consolidated financial statements in accordance with GAAP.  Those estimates and assumptions affect thereported amounts of assets, liabilities, revenues and expenses in theconsolidated financial statements, and the disclosure of contingent assets andliabilities.  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 effortsmethod of accounting for our investments in oil and gas properties.  Under this method, oil and gas leaseacquisition costs and intangible drilling costs associated with explorationefforts that result in the discovery of proved reserves and costs associatedwith development drilling, whether or not successful, are capitalized whenincurred.  Certain costs of exploratorywells are capitalized pending determinations that proved reserves have beenfound.  If the determination is dependentupon the results of planned additional wells and required capital expendituresto produce the reserves found, the drilling costs will be capitalized as longas sufficient reserves have been found to justify completion of the exploratorywell and additional wells are underway or firmly planned to complete theevaluation of the well.  All costsrelated to unsuccessful exploratory wells are expensed when such wells aredetermined to be non-productive or at the one year anniversary of completion ofthe well if proved reserves have not been attributed and capital expendituresas described in the preceding sentence are not required.  We assess our capitalized exploratory wellspending evaluation each quarter to determine whether costs should remaincapitalized or should be charged to earnings. Other exploration costs, including geological and geophysical costs, areexpensed as incurred.  We will recognizegains or losses on the sale of properties, should they occur, on afield-by-field basis.

The application of the successfulefforts method of accounting requires management’s judgment to determine theproper designation of wells as either developmental or exploratory, which willultimately determine the proper accounting treatment of the costsincurred.  The results from a drillingoperation can take considerable time to analyze, and the determination thatcommercial reserves have been discovered requires both judgment and applicationof industry experience.  Wells may becompleted that are assumed to be productive and actually deliver oil and gas inquantities insufficient to be economic, which may result in the abandonment ofthe wells at a later date.  Theevaluations of oil and gas leasehold acquisition costs requires management’sjudgment to estimate the fair value of exploratory costs related to drillingactivity in a given area.

The successful efforts method ofaccounting can have a significant impact on the operational results reportedwhen we enter a new exploratory area in hopes of finding oil and gasreserves.  Seismic costs can be substantialwhich will result in additional exploration expenses when incurred.  The initial exploratory wells may beunsuccessful and the associated costs will then be expensed as dry hole costsand any associated leasehold costs may be impaired.

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

We periodically evaluate therecoverability of the carrying value of our long-lived assets and identifiableintangibles by monitoring and evaluating changes in circumstances that mayindicate the carrying amount of the asset may not be recoverable.  Examples of events or changes incircumstances that indicate that the recoverability of the carrying amount ofan 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 matter 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 performanceand anticipated future results in our evaluation of potential impairment.  Accordingly, when indicators of impairmentare present, we evaluate the carrying value of these assets in relation to theoperating performance of the business and future discounted and non-discountedcash flows expected to result from the use of these assets.  Impairment losses are recognized when theexpected future cash flows from an asset are less than its carrying value.

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

The accounting for futuredevelopment and abandonment costs changed on January 1, 2003, with theissuance of Statement of Financial Accounting Standards (“SFAS”) No. 143 “Accountingfor Asset Retirement Obligation” (“ARO”), which requires the fair value of aliability for an asset retirement obligation to be recognized in the period inwhich it is incurred if a reasonable estimate of fair value can be made.  The associated asset retirement costs arecapitalized as part of the carrying amount of the long-lived asset.  The accrual is based on estimates of thesecosts for each of our properties based upon the type of production structure,reservoir characteristics, depth of the reservoir, market demand for equipment,

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currently available procedures and consultations withconstruction and engineering consultants. 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 and estimatesas to the proper discount rate to use and timing of abandonment.

TheCompany acquired four offshore platforms in connection with its Block Z-1property. These platforms revert back to the Government of Peru at the end ofthe contract, provided they are in good working condition, with no furtherobligation to the company to dismantle or remove them. The Company and itslegal advisors have reviewed Peruvian law and existing regulations from thePeruvian Ministry of Energy and Mines in conjunction with the requirements ofSFAS 143 and have concluded that there is no legal obligation to dismantle theplatforms, as defined in SFAS 143, and therefore recognition of an ARO is notrequired. If, however, current laws or regulations were changed or the platformswere no longer in good working order, the Company could be obligated todismantle and remove them. In addition, our plan of operations includes the drilling of wells andthe construction of an electric power generation plant.  We will be required to plug and abandon thosewells and restore the well site and power generation site upon completion oftheir production.  However, due to thefact that we have not yet begun operations, we do not have sufficientinformation to determine the timing, nor calculate the present value, of theobligation.  Therefore, no ARO provisionis reflected in the accompanying consolidated financial statements.

**Disclosure Regarding Forward-Looking Statements**

We caution that this document containsforward-looking statements.  All statements,other than statements of historical facts, included in or incorporated byreference into this Form 10-Q which address activities, events ordevelopments which we expect, believe or anticipate will or may occur in thefuture are forward-looking statements. The words “believes,” “intends,” “expects,”“anticipates,” “projects,” “estimates,” “predicts,” “plans” and similarexpressions, or the negative thereof, are also intended to identifyforward-looking statements.  Inparticular, statements, expressed or implied, concerning future operatingresults, the ability to replace or increase reserves, or to increaseproduction, or the ability to generate income or cash flows are by nature,forward-looking statements.  Thesestatements are based on certain assumptions and analyses made by the managementof BPZ in light of its experience and its perception of historical trends,current conditions and expected future developments as well as other factors itbelieves are appropriate in the circumstances. However, forward-lookingstatements are not guarantees of performance and no assurance can be given thatthese expectations will be achieved.

Important factors that could cause actual resultsto differ materially from the expectations reflected in the forward-lookingstatements include, but are not limited to any of the following in thejurisdictions in which BPZ or its subsidiaries are doing business:  the timing and extent of changes in commodityprices for crude oil, natural gas and related products, currency exchangerates, interest rates, inflation, the availability of goods and services,drilling and other operational risks, availability of capital resources,legislative or regulatory changes, political developments, acts of war andterrorism.  A more detailed discussion onrisks relating to the oil and natural gas industry and to us is included in theCompany’s Annual Report on Form 10-KSB/A for the year endedDecember 31, 2005.

In light of these risks, uncertainties andassumptions, we caution the reader that these forward-looking statements aresubject to risks and uncertainties, many of which are beyond our control, whichcould cause actual events or results to differ materially from those expressedor implied by the statements.  Allsubsequent written and oral forward-looking statements attributable to us orpersons acting on our behalf are expressly qualified in their entirety by thecautionary statements.  We undertake noobligations to update or revise its forward-looking statements, whether as aresult of new information, future events or otherwise.

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

*Market Risk.*

We are currentlyexposed to market risk primarily related to adverse changes in oil and naturalgas prices and interest rates.  Forinformation regarding our exposure to certain market risks, see Item 3. “Quantitativeand Qualitative Disclosure About Market Risks” in our annual report filed onForm 10-KSB/A for the year ended December 31, 2005, as filed with the Securities and Exchange Commissionon October 16, 2006. There have been no significant changes in our market riskfrom what was disclosed in the Form 10-KSB/A for the year ended December 31,2005.

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*Foreign Currency Exchange Rate Risk*

In addition to the U.S.Dollar, we conduct our business in Peruvian Nuevo Soles and therefore aresubject to foreign currency exchange rate risk on cash flows related toexpenses and investing transactions. We do not expect to generate significantrevenue from activities in Peru prior to late 2007. In recent years, theexchange rate between U.S. Dollars and Nuevo Soles has been relativelyconstant. Consequently, we have experienced no significant fluctuations in thevalue of goods and services we purchase in Peru because of currency exchange.

Themajority of our costs to operate our Peruvian offices and our exploration costsincurred for activities currently underway in Peru are denominated in U.S.Dollars. However, our exploration costs in Peru may be incurred under contractsdenominated in Peruvian Nuevo Soles or U.S. Dollars. To date, we have notengaged in hedging activities to hedge our foreign currency exposure. In thefuture, we may enter into hedging instruments to manage our foreign currencyexchange risk or continue to be subject to exchange rate risk.

**Item4.  Controls and Procedures**

**(a) Evaluation of Disclosure Controls and Procedures**

As of the end of the period covered by this report,we carried out an evaluation, under the supervision and with the participationof our management, including our Chief Executive Officer and Vice President -Finance and Chief Accounting Officer, of the effectiveness of our disclosurecontrols and procedures as defined in Rule 13a-15(e) of the Exchange Act.  Based upon that evaluation our ChiefExecutive Officer and Vice President - Finance and Chief Accounting Officer concludedthat our disclosure controls and procedures were not effective as of the end ofthe period covered by this report to provide reasonable assurance thatinformation required to be disclosed by the Company in the reports that theCompany files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms.

OnJanuary 17, 2006, the Company amended its 2004 Annual Report on Form 10-KSB/Aand Quarterly Reports on Form 10-QSB/A for the periods ended March 31, 2005 andJune 30, 2005.  On September 26, 2006,the Company amended its 2005 Annual Report on Form 10-KSB filed on March 31,2006.  On October 16, 2006 the Companyfiled a further amendment to its 2005 Annual Report on Form 10-KSB/A filed onSeptember 26, 2006.  The restatements area result of deficiencies in our internal controls and relate to the failure toproperly (i) account for and describe the September 2004 merger with Navidec,Inc.; (ii) value certain options assumed by the Company; (iii) account for thepost-merger operations of Navidec Financial Services, Inc.; and (iv) accountfor expenses incurred on the Company’s behalf by its former parent, BPZ &Associates, Inc., prior to the merger. The Company’s management and AuditCommittee have discussed these restatement issues and related internal controlsdeficiencies with Johnson Miller & Co., CPA’s PC, its independentregistered public accounting firm, and has appropriately recorded and disclosedthose items in the Amendment No. 1 and Amendment No. 2 to its 2005 AnnualReport on From 10-KSB/A.

**(b) Changes in Internal Control over Financial Reporting**

Weare in the process of improving our internal controls in an effort to remediatethe deficiencies noted above. These improvements include strengthening ouraccounting and financial reporting departments through the hiring of additionalqualified accounting staff.  We have alsoengaged an independent consulting firm to document and test our internalcontrols and make recommendations for improvement. Additional effort may beneeded to fully remedy these deficiencies and we are continuing our efforts toimprove and strengthen our control processes and procedures. Our management anddirectors will continue to work with our auditors and other outside advisors toensure that our controls and procedures become adequate and effective.

**PART II**

**Item 1.  Legal Proceedings**

SeeNote 11 of the Notes to Consolidated Financial Statements included inPart I, Item 1, which is incorporated herein by reference.

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**Item 1A.  Risk Factors**

Thereare no material changes from risk factors as previously described on Form10-KSB/A for the year ended December 31, 2005.

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

OnMarch 10, 2006, the Company completed a private placement of 1,670,000 sharesof common stock, no par value, to four institutional and accredited investorspursuant to a Stock Purchase Agreement dated as of March 8, 2006. The commonstock was priced at $3.00 per share resulting in proceeds to the Company of$5,010,000.  In connection with the offerand sale of the common stock in the private placement, the Company relied on anexemption from registration under Section 4(2) of the Securities Act of 1933,as amended, and Regulation D, Rule 506 promulgated there under. The sale ofcommon stock was made to accredited investors as defined in Regulation D, Rule501(a). No underwriters were engaged in connection with the foregoing issuanceof securities. Under the terms of the private placement agreement, the Companywas obligated to prepare and file with the SEC a registration statement withinsixty days, and to use its best efforts to cause the registration statement tobe declared effective by the SEC no later than ninety days from March 8,2006. The registration statement was not filed or declared effective by therequired dates, and the Company became liable to the investors for liquidateddamages in an amount equal to 1.0% of the purchase price of the shares,approximately $50,100, for each thirty day period until the registrationstatement is declared effective by the SEC. These liquidated damages werepayable, at the sole discretion of the Company, by cash or by the issuance ofCompany common stock. Accordingly, 90,334 shares of common stock were issued,as of October 30, 2006, to those investors as liquidated damages for theperiod of June 7, 2006 through October 5, 2006.

OnJune 30, 2006, the Company completed a private placement of 4,482,000 shares ofcommon stock, no par value, to eight institutional and accredited investorspursuant to a Stock Purchase Agreement dated as of June 30, 2006. The commonstock was prices at $2.75 per share resulting in proceeds to the Company of$12,325,500.  In connection with theoffer and sale of the common stock in the private placement, the Company reliedon an exemption from registration under Section 4(2) of the Securities Act of1933, as amended, and Regulation D, Rule 506 promulgated there under. The saleof common stock was made to accredited investors as defined in Regulation D,Rule 501(a). No underwriters were engaged in connection with the foregoingissuance of securities.  Under the termsof the private placement agreement, the Company was obligated to prepare andfile with the SEC a registration statement and to use its best efforts to causethe registration statement to be declared effective by the SEC no later thanninety days from July 19, 2005. The registration statement was notdeclared effective by the required date, and the Company became liable to theinvestors for liquidated damages in an amount equal to 1.0% of the purchaseprice of the shares, approximately $343,980, for each thirty day period until theregistration statement was declared effective by the SEC. Certain of theprivate placement investors, totaling 79% of the aggregate investment,  agreed to accept common stock in lieu of cashfor a maximum period of 90 days. Accordingly, 867,609 shares of commonstock have been issued, as of October 30, 2006, to those certain investorsfor liquidated damages for the period of December 16, 2005 throughOctober 13, 2006.

On November 8, 2006, the SEC declared effective the Registration Statement on Form S-1 covering the common shares issued in connection with the July 19, 2005, March 10, 2006, and June 30, 2006, private placements.  As a result, the Company is no longer subject to the liquidated damages described above.

**Item 3.  Defaults Upon Senior Securities**

None.

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

None.

**Item 5.  Other Information**

None.

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**Item 6.  Exhibits**
| 31.1   | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. (Filed herewith)                                                                       |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                  |
| 31.2   | Certification of the VP – Finance and Chief Accounting Officer pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. (Filed herewith)                                                |
|   |                                                                                                                                                                                                  |
| 32.1   | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. (Filed herewith)                        |
|   |                                                                                                                                                                                                  |
| 32.2   | Certification of VP – Finance and Chief Accounting Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. (Filed herewith) |

 

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**SIGNATURES**

In accordance with the requirements of the Securities Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| BPZ ENERGY, INC.                      |
|---------------------------------------|
|                                  |
| */s/ Manuel Pablo Zuniga-Pflucker*    | * * |
| Manuel Pablo Zuniga-Pflucker          |
| President and Chief Executive Officer |
|                                  |
| Date: November 16, 2006               |

 

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