**Table of Contents**

** **

 

** **

**UNITED STATES**

**SECURITIES 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: March 31, 2010**                                                                                                                                                                  |
| ** **                                                                                                                                                                                                                |
| **or**                                                                                                                                                                                                                    |
| ** **                                                                                                                                                                                                                |
| **o**                                                                                                                                                                                                                     | **TRANSITION REPORT PURSUANT TO  SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                                |
| **For the transition period  from               to               ** |

 

**Commission File Number: 001-12697**

 

**BPZRESOURCES, INC.**

(Exact Name of Registrant as Specified in Its Charter)

 

| **Texas**                                                      | ** ** | **33-0502730**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of Incorporation or Organization) |       | (I.R.S. Employer Identification No.) |

 

**580 Westlake Park Blvd., Suite 525Houston, Texas 77079**(Address of Principal Executive Office)

 

Registrant’s Telephone Number, Including Area Code:** (281)556-6200**

 

**N/A**

(Former Name, Former Address and Former Fiscal Year, If Changed SinceLast Report)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x   No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o   No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act:

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange 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 May 04, 2010, there were 115, 223,926 shares of commonstock, no par value, outstanding.

 

 

 

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Table of Contents

 

**TABLEOF CONTENTS**

 
| ** ** | **PART I**                                                                             | 3      |
|------------|---------------------------------------------------------------------------------------------|--------|
|       |                                                                                        |   |
| Item 1.    | Financial Statements                                                                        | 3      |
|       |                                                                                        |   |
|       | Consolidated  Balance Sheets                                                                | 3      |
|       |                                                                                        |   |
|       | Consolidated  Statements of Operations                                                      | 4      |
|       |                                                                                        |   |
|       | Consolidated  Statements of Cash Flows                                                      | 5      |
|       |                                                                                        |   |
|       | Notes  to Consolidated Financial Statements                                                 | 6      |
|       |                                                                                        |   |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 23     |
|       |                                                                                        |   |
| Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                 | 39     |
|       |                                                                                        |   |
| Item 4.    | Controls and  Procedures                                                                    | 40     |
|       |                                                                                        |   |
| ** ** | **PART II**                                                                            | 41     |
|       |                                                                                        |   |
| Item 1.    | Legal Proceedings                                                                           | 41     |
|       |                                                                                        |   |
| Item 1A.   | Risk Factors                                                                                | 41     |
|       |                                                                                        |   |
| Item 6.    | Exhibits                                                                                    | 41     |
|       |                                                                                        |   |
|       | **SIGNATURES**                                                                              | 42     |

 

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**PART I**

 

# **Item 1. Financial Statements**

#  

**BPZ Resources, Inc. and Subsidiaries**

**Consolidated BalanceSheets**

**(In thousands,****except share par valueamounts****)**

** **
| ** **                                                                                                                                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                           | ** ** | **(Unaudited)**    | ** ** | **(Audited)**         | ** ** |
| **ASSETS**                                                                                                                                                           |       |               |       |                  |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Current  assets:                                                                                                                                                     |       |               |       |                  |       |
| Cash  and cash equivalents                                                                                                                                           |       | $                  | 131,157    |                  | $          | 18,147 |   |
| Accounts  receivable                                                                                                                                                 |       | 10,855             |       | 2,867                 |       |
| Value  added tax receivable                                                                                                                                          |       | 28,121             |       | 26,152                |       |
| Inventory                                                                                                                                                            |       | 14,663             |       | 12,507                |       |
| Prepaid  and other current assets                                                                                                                                    |       | 6,997              |       | 1,580                 |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Total  current assets                                                                                                                                                |       | 191,793            |       | 61,253                |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Property,  equipment and construction in progress, net                                                                                                               |       | 292,005            |       | 262,517               |       |
| Restricted  cash                                                                                                                                                     |       | 5,515              |       | 5,720                 |       |
| Other  non-current assets                                                                                                                                            |       | 6,297              |       | 1,559                 |       |
| Investment  in Ecuador property, net                                                                                                                                 |       | 1,148              |       | 1,195                 |       |
| Deferred  tax asset                                                                                                                                                  |       | 19,210             |       | 16,928                |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Total  assets                                                                                                                                                        |       | $                  | 515,968    |                  | $          | 349,172 |   |
|                                                                                                                                                                 |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                       |       |               |       |                  |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                |       |               |       |                  |       |
| Accounts  payable                                                                                                                                                    |       | $                  | 30,657     |                  | $          | 32,698 |   |
| Accrued  liabilities                                                                                                                                                 |       | 12,086             |       | 14,155                |       |
| Other  liabilities                                                                                                                                                   |       | 1,124              |       | 1,235                 |       |
| Current  income taxes payable                                                                                                                                        |       | 1,128              |       | 322                   |       |
| Accrued  interest payable                                                                                                                                            |       | 1,943              |       | 106                   |       |
| Current  maturity of long-term debt and capital lease obligations                                                                                                    |       | 6,912              |       | 5,352                 |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Total  current liabilities                                                                                                                                           |       | 53,850             |       | 53,868                |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Asset  retirement obligation                                                                                                                                         |       | 873                |       | 766                   |       |
| Long-term  debt and capital lease obligations                                                                                                                        |       | 155,831            |       | 22,581                |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Total  long-term liabilities                                                                                                                                         |       | 156,704            |       | 23,347                |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Commitments  and contingencies (Note 15)                                                                                                                             |       |               |       |                  |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Stockholders’  equity:                                                                                                                                          |       |               |       |                  |       |
| Preferred  stock, no par value, 25,000 authorized; none issued and outstanding                                                                                       |       | —             |       | —                |       |
| Common  stock, no par value, 250,000 authorized; 115,224 and 115,224 shares issued  and outstanding at March 31, 2010 and December 31, 2009,  respectively |       | 548,376            |       | 513,145               |       |
| Accumulated  deficit                                                                                                                                                 |       | (242,962           | )          | (241,188              | )          |
|                                                                                                                                                                 |       |               |       |                  |       |
| Total  stockholders’ equity                                                                                                                                     |       | 305,414            |       | 271,957               |       |
|                                                                                                                                                                 |       |               |       |                  |       |
| Total  liabilities and stockholders’ equity                                                                                                                     |       | $                  | 515,968    |                  | $          | 349,172 |   |

 

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

 

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**BPZ Resources, Inc. and Subsidiaries**

**Consolidated Statements of Operations****(Unaudited)**

**(In thousands, except per share data)**

** **
| ** **                                                                 | ** ** | **Three Months********Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                 | ** ** | **2010**                                     | ** ** | **2009** | ** ** |
|                                                                       |       |                                         |       |   |   |
| Revenue                                                                    |       | $                                            | 24,045     |   | $ | 13,225 |   |
|                                                                       |       |                                         |       |   |   |
| Operating  and administrative expenses:                                    |       |                                         |       |   |   |
| Lease  operating expense                                                   |       | 4,764                                        |       | 3,978 |   |
| General  and administrative expense                                        |       | 8,026                                        |       | 8,483 |   |
| Geological,  geophysical and engineering expense                           |       | 501                                          |       | 347 |   |
| Depreciation,  depletion and amortization expense                          |       | 9,489                                        |       | 7,878 |   |
|                                                                       |       |                                         |       |   |   |
| Total  operating expenses                                                  |       | 22,780                                       |       | 20,686 |   |
|                                                                       |       |                                         |       |   |   |
| Operating  income (loss)                                                   |       | 1,265                                        |       | (7,461 | ) |
|                                                                       |       |                                         |       |   |   |
| Other  income (expense):                                                   |       |                                         |       |   |   |
| Income  (expense) from investment in Ecuador property, net of amortization |       | (47                                          | )          | (47 | ) |
| Interest  expense                                                          |       | (1,940                                       | )          | — |   |
| Interest  income                                                           |       | 64                                           |       | 25 |   |
| Other  income (expense)                                                    |       | 6                                            |       | (772 | ) |
|                                                                       |       |                                         |       |   |   |
| Total  other expense, net                                                  |       | (1,917                                       | )          | (794 | ) |
|                                                                       |       |                                         |       |   |   |
| Loss  before income taxes                                                  |       | (652                                         | )          | (8,255 | ) |
|                                                                       |       |                                         |       |   |   |
| Income  tax expense (benefit)                                              |       | 1,122                                        |       | (1,207 | ) |
|                                                                       |       |                                         |       |   |   |
| Net  loss                                                                  |       | $                                            | (1,774     | ) | $ | (7,048 | ) |
|                                                                       |       |                                         |       |   |   |
| Basic  and diluted net loss per share                                      |       | $                                            | (0.02      | ) | $ | (0.08 | ) |
| Weighted  average common shares outstanding                                |       | 115,224                                      |       | 88,620 |   |

 

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

 

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**BPZ Resources, Inc. andSubsidiaries**

**Consolidated Statements ofCash Flows (Unaudited)**

**(In thousands)**

 
| ** **                                                                                 | ** ** | **For the Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                                       | ** ** | **2009** | ** ** |
|                                                                                       |       |                                           |       |   |   |
| Cash  flows from operating activities:                                                     |       |                                           |       |   |   |
| Net  loss                                                                                  |       | $                                              | (1,774     | ) | $ | (7,048 | ) |
| Adjustments  to reconcile net loss to net cash provided by (used in) operating activities: |       |                                           |       |   |   |
| Stock-based  compensation                                                                  |       | 1,856                                          |       | 3,274 |   |
| Depreciation,  depletion and amortization                                                  |       | 9,489                                          |       | 7,878 |   |
| Amortization  of investment in Ecuador property                                            |       | 47                                             |       | 47 |   |
| Deferred  income taxes                                                                     |       | (2,282                                         | )          | (2,541 | ) |
| Amortization  of deferred financing fees                                                   |       | 524                                            |       | — |   |
| Changes  in operating assets and liabilities:                                              |       |                                           |       |   |   |
| (Increase)  decrease in accounts receivable                                                |       | (7,988                                         | )          | 1,495 |   |
| Increase  in value added tax receivable                                                    |       | (1,969                                         | )          | (4,206 | ) |
| Increase  in inventory                                                                     |       | (793                                           | )          | (2,874 | ) |
| Increase  in other assets                                                                  |       | (5,421                                         | )          | (69 | ) |
| (Decrease)  increase in accounts payable                                                   |       | (2,041                                         | )          | 5,373 |   |
| Decrease  in accrued liabilities                                                           |       | (231                                           | )          | (1,459 | ) |
| Increase  in income taxes payable                                                          |       | 806                                            |       | 1,004 |   |
| (Decrease)  increase in other liabilities                                                  |       | (112                                           | )          | 565 |   |
| Net  cash provided by (used in) operating activities                                       |       | (9,889                                         | )          | 1,439 |   |
|                                                                                       |       |                                           |       |   |   |
| Cash  flows from investing activities:                                                     |       |                                           |       |   |   |
| Property  and equipment additions                                                          |       | (40,232                                        | )          | (17,832 | ) |
| Decrease  in restricted cash                                                               |       | 205                                            |       | 902 |   |
| Net  cash used in investing activities                                                     |       | (40,027                                        | )          | (16,930 | ) |
|                                                                                       |       |                                           |       |   |   |
| Cash  flows from financing activities:                                                     |       |                                           |       |   |   |
| Borrowings                                                                                 |       | 170,938                                        |       | 1,000 |   |
| Repayments  of borrowings                                                                  |       | (1,968                                         | )          | (2,841 | ) |
| Deferred  loan fees                                                                        |       | (6,044                                         | )          | — |   |
| Proceeds  from sale of common stock, net                                                   |       | —                                         |       | 40,497 |   |
| Net  cash provided by financing activities                                                 |       | 162,926                                        |       | 38,656 |   |
|                                                                                       |       |                                           |       |   |   |
| Net  increase in cash and cash equivalents                                                 |       | 113,010                                        |       | 23,165 |   |
| Cash  and cash equivalents at beginning of period                                          |       | 18,147                                         |       | 5,317 |   |
| Cash  and cash equivalents at end of period                                                |       | $                                              | 131,157    |   | $ | 28,482 |   |
|                                                                                       |       |                                           |       |   |   |
|                                                                                       |       |                                           |       |   |   |
| Supplemental  cash flow information:                                                       |       |                                           |       |   |   |
| **Cash paid for:**                                                                         |       |                                           |       |   |   |
| Interest                                                                                   |       | $                                              | 997        |   | $ | 879 |   |
| Income  tax                                                                                |       | 3,025                                          |       | 330 |   |
| **Non — cash items:**                                                                 |       |                                           |       |   |   |
| Issuance  of common stock for subscription receivable                                      |       | $                                              | —     |   | $ | 4,364 |   |
| Accrued  interest capitalized to construction in progress                                  |       | —                                         |       | 23 |   |
| Depletion  allocated to production inventory                                               |       | 1,363                                          |       | 613 |   |
| Depreciation  on support equipment capitalized to construction inprogress                  |       | 359                                            |       | 339 |   |
| Asset  retirement obligation capitalized to property and equipment                         |       | 85                                             |       | — |   |
| Property  and equipment transferred to other non-current assets                            |       | —                                         |       | (1,428 | ) |

 

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

 

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**BPZResources, Inc. and Subsidiaries**

**Notes To Consolidated Financial Statements**

**(Unaudited)**

 

**Note 1- Basis of Presentation and Significant Accounting Policies**

** **

**Organization**

** **

BPZ Resources, Inc., (together with itssubsidiaries, collectively referred to as the “Company” or “BPZ” unless thecontext requires otherwise) a Texas corporation, is based in Houston, Texaswith offices in Lima, Peru and Quito, Ecuador. The Company is focused on theexploration, development and production of oil and natural gas in Peru and to alesser extent Ecuador. The Company also intends to utilize part of its plannedfuture natural gas production as a supply source for the complementarydevelopment of a gas-fired power generation facility which is expected to bewholly or partially owned by the Company.

 

The Company maintains a subsidiary, BPZ Exploración &Producción S.R.L. (“BPZ E&P”), registered in Peru through its wholly-ownedsubsidiary BPZ Energy, LLC, a Texas limited liability company, formerlyBPZ Energy, Inc., and its subsidiary BPZ Energy International Holdings,L.P., a British Virgin Islands limited partnership. Currently, the Company,through BPZ E&P, has exclusive rights and license contracts for oil and gasexploration and production covering a total of approximately 2.2 million acres,in four blocks, in northwest Peru. The Company’s license contracts cover 100%ownership of the following properties: Block Z-1 (0.6 million acres), Block XIX(0.5 million acres), Block XXII (0.9 million acres) and Block XXIII (0.2million acres). The Block Z-1 contract was signed in November 2001, theBlock XIX contract was signed in December 2003 and the Blocks XXII andXXIII contracts were signed in November 2007. Generally, according tothe Organic Hydrocarbon Law No. 26221 and the regulations thereunder (the “OrganicHydrocarbon Law” or “Hydrocarbon Law”) the seven year term for the explorationphase can be extended in each contract by an additional three years up to amaximum of ten years. However, specific provisions of each license contract canvary the exploration phase of the contract as established by the Hydrocarbon Law.The license contracts require the Company to conduct specified activities inthe respective blocks during each exploration period in the exploration phase.If the exploration activities are successful, the Company may decide to enterthe exploitation phase and the total contract term can extend up to 30 yearsfor oil exploration and production and up to 40 years for gas exploration andproduction. In the event a block contains both oil and gas, as is the case inthe Company’s Block Z-1 contract, the 40 year term may apply to oil explorationand production as well.

 

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

 

The Company is in the process of developing its oiland natural gas reserves.  The Companyhas been producing and selling oil from the CX-11 platform in the Corvina fieldof Block Z-1 under a well testing program and is in the process of satisfyingthe conditions to transition to commercial production in Corvina. The Companyis also in the initial stages of appraising, exploring and developing thepotential oil and natural gas reserves from the A platform in the Albacorafield of Block Z-1, and has drilled and completed its first well in December 2009.From the time the Company first began producing from the CX-11 platform in theCorvina field in November of 2007 and the Albacora field in December 2009,through March 31, 2010, it has produced approximately 2.3 MMBbls of oil.Additionally, the Company’s activities in Peru include analysis and evaluationof technical data on its other properties, preparation of the development plansfor the properties, refurbishment of and designs for platforms, procuringmachinery and equipment for an extended drilling campaign, obtaining allnecessary environmental and operating permits, bringing additional productionon-line, seismic acquisition, obtaining detailed engineering and design of thepower plant and gas processing facilities, executing a contract to purchasethree LM 6000 gas-fired turbines and securing the required capital andfinancing to conduct the current plan of operation.

 

**Basis of Presentation and Principles of Consolidation**

 

The accompanyingconsolidated financial statements of BPZ Resources, Inc. and itssubsidiaries have been prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP” or “U.S. GAAP”) for interim financial information andwith the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly,certain information and footnote disclosures normally included in financialstatements prepared in accordance with GAAP have been condensed or omittedpursuant to such rules and regulations. The unaudited financial statementsreflect all adjustments which are, in the opinion of management, necessary fora fair presentation of the financial position and results of operations for theinterim periods presented on a basis consistent with the annual auditedfinancial statements.  All suchadjustments are of a normal, recurring nature. All significant transactions between BPZ and itsconsolidated subsidiaries have been eliminated. Certain prior period amountshave been reclassified to conform to current year presentation. Results ofoperations for interim periods are not necessarily indicative of the results ofoperations that may be expected for the entire year. The balance sheet at December 31,2009 has been derived from the audited

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

financial statements atthat date but does not include all of the information and footnotes required byGAAP for complete financial statements. These interim financial statementsshould be read in conjunction with the audited financial statements and notesthereto included in the Company’s Annual Report on Form 10-K, as amended,for the year ended December 31, 2009.

** **

**Useof Estimates**

** **

The preparation of the consolidated financialstatements in accordance with U.S. GAAP requires management to make certainestimates and assumptions. These estimates and assumptions affect the reportedamounts of assets, liabilities, revenues and expenses in the consolidatedfinancial statements, and the disclosure of contingent assets and liabilities.Actual results could differ from these estimates.

 

Estimates of crude oil reserves are the mostsignificant of the Company’s estimates. All of the Company’s reserves data areestimates. Reservoir engineering is a subjective process of estimatingunderground accumulations of crude oil and natural gas. There are numerousuncertainties inherent in estimating quantities of proved crude oil and naturalgas reserves. The accuracy of any reserves estimate is a function of thequality of available data and of engineering and geological interpretation andjudgment. As a result, reserves estimates may be different from the quantitiesof crude oil and natural gas that are ultimately recovered.

 

Other items subject to estimates and assumptionsinclude the carrying amounts of property, plant and equipment includingimpairment and asset retirement obligations and deferred income tax assets.Management evaluates estimates and assumptions on an ongoing basis usinghistorical experience and other factors, including the current economic andcommodity price environment and future expectations regarding estimates andassumptions. As future events and their effects cannot be determinedaccurately, actual results could differ significantly from management’sestimates.

 

**Summaryof Significant Accounting Policies**

 

The Company has provideda summary discussion of significant accounting policies, estimates andjudgments in Note 1 to the Notes to Consolidated Financial Statements includedin its Annual Report on Form 10-K, as amended, for the year ended December 31,2009.

 

**Recent Accounting Pronouncements**

 

In February 2010, the Financial Accounting Standards Board (“FASB”)issued Accounting Standards Update (“ASU”) No. 2010-09, “SubsequentEvents,” which amends Accounting Standards Codification (“ASC”) Topic 855 toeliminate the requirement to disclose the date through which management hasevaluated subsequent events in the financial statements. ASU No. 2010-09was effective upon issuance and its adoption had no impact on the Company’sfinancial position, results of operations or cash flows.

 

In January 2010, the Company partially adoptedthe provisions of FASB ASU No. 2010-06, “Improving Disclosures about FairValue Measurements,” which amends ASC Topic 820 to require new disclosuresconcerning (1) transfers into and out of Levels 1 and 2 of the fair valuemeasurement hierarchy, and (2) activity in Level 3 measurements. Inaddition, ASU No. 2010-06 clarifies certain existing disclosurerequirements regarding the level of disaggregation and inputs and valuationtechniques and makes conforming amendments to the guidance on employers’disclosures about postretirement benefit plans assets. The requirements todisclose separately purchases, sales, issuances, and settlements in the Level 3reconciliation are effective for fiscal years beginning after December 15,2010 (and for interim periods within such years). As such, the Company willapply the disclosure requirements relative to the Level 3 reconciliation in thefirst quarter of 2011. There was no impact on the Company’s financial position,results of operations or cash flows as a result of the partial adoption of ASU No. 2010-06.For further information, please see Note 11, “Fair Value Measurements andDisclosures”.

 

**Note 2 —Value-Added Tax Receivable**

 

Value-added tax (referred to as “IGV” in Peru) isgenerally imposed on goods and services at a rate of 19%.

 

Peru currently has an IGV early recovery program foroil and gas companies during the exploration phase. Under this program, IGVpaid on the acquisition of certain goods and services used directly inhydrocarbon exploration activities can be recovered prior to a commercialdiscovery taking place or the initiation of production and revenue billings.Because the Company has

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

oil sales in the Corvina field under a well testingprogram, it is no longer eligible for the IGV early recovery program. Accordingly,the Company is recovering its IGV receivable with IGV payables associated withfuture oil sales under the normal IGV recovery process.

 

The Company’s value-added tax receivable balance as ofMarch 31, 2010 and December 31, 2009 was $28.1 million and $26.2million, respectively. For the three months ended March 31, 2010 theCompany accrued approximately $8.5 million for IGV related to expenditures reduced by approximately $6.6million for IGV related to the sale of oil for the same period.

 

**Note 3 — Inventories**

 

Inventories consist primarily of crude oil, tubulargoods, accessories and spare parts for production equipment, stated at thelower of average cost or market. The balance of inventory at March 31,2010 and December 31, 2009 was $14.7 million and $12.5 million,respectively.

 

Inventory associated with tubular goods, accessoriesand spare parts inventory at March 31, 2010 and December 31, 2009 was$9.4 million and $10.5 million, respectively.

 

For oil produced from the Corvina field, the Companymaintains crude oil inventories in storage vessels until the inventoryquantities are at a sufficient level that the refinery in Talara will acceptdelivery.  Currently, all oil produced from the Albacora field, 90,453barrels at March 31, 2010, is being kept in inventory until the Companyobtains a sales contract, to sell the oil produced and arranges delivery terms.These inventories are also stated at the lower of average cost or market value.Cost is determined on a weighted average basis based on production costs. Thecrude oil inventory at March 31, 2010 consisted of approximately 155,413barrels at an estimated cost of $5.3 million or $33.86 per barrel.The crude oil inventory at December 31,2009 consisted of approximately 40,108 barrels at an estimated cost of $2.0million or $50.55 per barrel.

 

**Note 4 — Prepaid and Other Current Assets andOther Non-Current Assets**

 

Belowis a summary of prepaid and other current assets as of March 31, 2010 and December 31,2009:

 
| ** **                  | ** ** | **March 31,********2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                  | ** ** | **(in thousands)**             | ** ** |
| Prepaid  expenses and other |       | $                              | 5,882      |                        | $          | 296 |   |
| Deposits                    |       | 115                            |       | 92                          |       |
| Prepaid  insurance          |       | 388                            |       | 580                         |       |
| Insurance  receivable       |       | 612                            |       | 612                         |       |
|                        |       | $                              | 6,997      |                        | $          | 1,580 |   |

 

Prepaid expenses and other are related to prepaymentsfor drilling services, equipment rental and material procurement. Deposits areprimarily rent deposits in connection with the Company’s offices in Houston andPeru. Prepaid insurance consists of premiums related to the Company’soperations as well as general liability and directors and officer’s insurancepolicies. Insurance receivable is related to the barge incident which occurredin early August 2006. The Company incurred an operational delay ofapproximately three weeks resulting from a navigation incident which caused theBPZ-01 barge to be grounded on a sand bank in Talara Bay in northwest Peruduring the second mobilization trip to the Corvina platform. As of March 31,2010, the Company has an insurance receivable of approximately $0.7 million forthe estimated insurance repair claims of $0.8 million expected to be filed withthe insurance carrier. A deductible of $75,000 will be applied to thisinsurance claim when reimbursed.  The hull claim will be finalized uponthe dry docking of the vessel, which is expected to occur during the thirdquarter of 2010.

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

Belowis a summary of other non-current assets as of March 31, 2010 and December 31, 2009:

 
| ** **        | ** ** | **March 31,********2010** | ** ** | **December 31,  2009** | ** ** |
|-------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **        | ** ** | **(in thousands)**        | ** ** |
| Debt  issue costs |       | $                              | 4,838      |                        | $          | 104 |   |
| Other  receivable |       | 1,459                          |       | 1,455                       |       |
|              |       | $                              | 6,297      |                        | $          | 1,559 |   |

 

Other non-current assetsconsist of (i) direct transaction costs incurred by the Company inconnection with its debt capital raising efforts and (ii) claims relatedto an incident involving a small tanker that one of our marine transportationcontractors was chartering from the Peruvian Navy’s commercial branch in 2008. As of March 31, 2010, the Company iscurrently seeking recovery of these amounts from the Peruvian Navy’s commercialbranch.  Due to the uncertainty in timingof resolving the claims, the Company has classified the amount as a non-currentasset.

 

In connection with the $15.0 million InternationalFinance Corporation (“IFC”) Reserve-Based Credit Facility, the Company incurredapproximately $0.2 million of debt issue costs that are being amortized overthe life of the loan agreement, due December 2012. In connection with the$170.9 Million Convertible Notes due 2015, the Company incurred approximately $4.8million of debt issue costs that are being amortized over the life of theindenture agreement, due March 2015.  For the three months ended March 31, 2010, the Company amortizedinto interest expense $0.1 million of debt issue costs. For the same period in2009, the amortization of debt issue costs was not material. For furtherinformation regarding the Company’s debt, see Note 9, “Long-Term Debt and Capital Lease Obligations”.

 

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

 

Below is a summary of property, equipment and construction in progress as of March 31, 2010 and December 31, 2009:

 
| ** **                                             | ** ** | **March 31,********2010** | ** ** | **December 31,  2009** | ** ** |
|--------------------------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **(in thousands)**             | ** ** |
| Construction  in progress:                             |       |                           |       |                        |       |
| Power  plant and related equipment                     |       | $                              | 31,593     |                        | $          | 28,113 |   |
| Platforms  and wells                                   |       | 23,127                         |       | 16,726                      |       |
| Pipelines  and processing facilities                   |       | 7,235                          |       | 5,537                       |       |
| Other                                                  |       | 17,091                         |       | 8,181                       |       |
| Producing  properties                                  |       | 219,321                        |       | 199,686                     |       |
| Producing  equipment                                   |       | 13,162                         |       | 13,160                      |       |
| Barge  and related equipment                           |       | 36,245                         |       | 35,842                      |       |
| Office  equipment, leasehold improvements and vehicles |       | 2,342                          |       | 2,193                       |       |
| Accumulated  depletion, depreciation and amortization  |       | (58,111                        | )          | (46,921                     | )          |
| Net  property, equipment and construction in process   |       | $                              | 292,005    |                        | $          | 262,517 |   |

 

During the threemonths ended March 31, 2010, the Company incurred capital expenditures ofapproximately $40.7 million associated with its development initiativesfor the exploration and production of oil and natural gas reserves and thecomplementary development of a proprietary gas-fired power generation facilityin Peru.

 

Of the incurred costs mentioned above, the Companyincurred capital expenditures related to the drilling and testing of theCX11-19D, CX11-17D and CX11-22D in the Corvina field of approximately, $0.1million, $7.5 million and $7.4 million, respectively. In the Albacora field,the Company incurred capital expenditures related to the drilling of the A-15Dand A-16D of approximately $8.6 million and $1.8 million, respectively.

 

In 2009, the Company entered into a lease-purchaseagreement to acquire the Don Fernando barge to serve as the Company’sconstruction lay barge as well as tender assist barge for drilling andconstruction operations and will eventually be fitted to

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

lay subsea pipe for the gas-to-power project.  During the three months ended March 31,2010, the Company capitalized an additional $4.6 million in order to have thebarge ready to support its operations.

 

For the further development of the planned gas-firedpower generation facility, BPZ incurred costs of approximately $3.0 million aspart of its agreement to purchase three LM6000 gas-fired turbines.

 

For the three months ended March 31, 2010, thecompany incurred approximately $0.3 million for upgrades to its existingplatforms as well as incurred costs toward the construction of new platforms.In addition, the Company incurred $1.5 million in equipment for its productionfacilities at the A platform in Albacora as well as at the CX-11 platform inCorvina. The Company incurred $0.2 million for the purchase of machinery andequipment used in operations in Peru, $0.1 million for the Caleta La Cruz dockrefurbishment, $3.6 million in assets in transit, $0.4 million in furniture andimprovements related to the new offices in Peru and $0.1 million related to theasset retirement obligation for the CX11-17D well.

 

For the three monthsended March 31, 2010, in accordance with the “successful efforts” methodof accounting, the Company capitalized approximately $0.4 million ofdepreciation expense, mainly related to the tender assist barges serving assupport equipment, and $1.4 million of interest expense to construction inprogress. For the same period in 2009, the Company capitalized approximately$0.3 million of depreciation expense and $0.9 million of interest expense,respectively, to construction in progress.

 

For the three monthsended March 31, 2010 and 2009, the Company recognized $9.5 million and$7.9 million of depreciation, depletion and amortization expense, respectively.

 

**Note 6— Asset Retirement Obligation**

 

An obligation was recorded for the future plug andabandonment of the producing oil wells in the Corvina and Albacora fields, inaccordance with the provisions of ASC Topic 410, “Asset Retirement andEnvironmental Obligations”.

 

Activity related to the Company’s asset retirementobligation (“ARO”) for March 31, 2010 and December 31, 2009 is asfollows:

*** ***
| ** **                             | ** ** | **March 31,********2010** | ** ** | **December 31,  2009** | ** ** |
|----------------------------------------|------------|--------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **(in thousands)**             | ** ** |
| ARO  as of the beginning of the period |       | $                              | 766        |                        | $          | 580 |   |
| Liabilities  incurred during period    |       | 85                             |       | 296                         |       |
| Accretion  expense                     |       | 22                             |       | 74                          |       |
| Revisions  in estimates during period  |       | —                         |       | (184                        | )          |
| ARO  as of the end of the period       |       | $                              | 873        |                        | $          | 766 |   |

 

**Note 7 — Investment in Ecuador Property**

 

The Company has a 10% net investment interest in an oiland gas property in Ecuador (the “Santa Elena Property”) totaling $1.1 millionand $1.2 million as of March 31, 2010 and December 31, 2009,respectively. The Company accounts for this investment under the cost methodand records its share of cash received or paid as other income or expense.Since the Company’s investment represents ownership of an oil and gas property,which is a depleting asset, the Company is amortizing the cost of theinvestment on a straight-line basis over the remaining term of the licenseagreement which expires in May 2016.  Investment expense from theCompany’s investment in Ecuador property was $47,000 for both the three months ended March 31,2010 and March 31, 2009, respectively. During both the three months ended March 31, 2010and March 31, 2009, the Company did not receive any income from itsinvestment in Ecuador property while recording investment amortization expenseof approximately $47,000.

 

**Note 8 — Restricted Cash and Performance Bonds**

 

As of March 31, 2010, the Company has restrictedcash deposits of $5.5 million. In connection with the Company’s properties inPeru, it obtained four performance bonds totaling $5.3 million that arepartially collateralized by restricted cash deposits of $3.1 million to insurecertain performance obligations and commitments under the license contracts forBlocks Z-1, XIX, XXII and

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

XXIII. Additionally, the Company has $2.4 million ofrestricted cash to collateralize insurance bonds for import duties related tothe BPZ-01 barge and crane on board the BPZ-01 and an unsecured performancebond of $0.1 million to guarantee its performance under an office leaseagreement in Peru.

 

As of December 31, 2009, the Company hadrestricted cash deposits of $5.7 million. In connection with the Company’sproperties in Peru, it obtained four performance bonds totaling $5.3 millionthat are partially collateralized by restricted cash deposits of $3.1 millionto insure certain performance obligations and commitments under the licensecontracts for Blocks Z-1, XIX, XXII and XXIII. Additionally, the Company had$1.6 million of restricted cash to collateralize insurance bonds for importduties related to the BPZ-01 barge and crane on board the BPZ-01. The Companyalso had $1.0 million of restricted cash held in a trust account in order tosecure financing to support our operations. In January 2010, the $1.0million of restricted cash held in a trust account was released in order tomake the final payment on the Company’s short-term loan agreement. Furthermore,the Company had an unsecured performance bond of $0.1 million to guarantee itsperformance under its new office lease agreement in Peru.

 

All of the performance and insurance bonds are issuedby Peruvian banks and their terms are governed by the corresponding licensecontracts, customs laws, lending practices or rental practices.

** **

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

*** ***

***At March 31, 2010 and December 31, 2009 long-termdebt and capital lease obligations consist of the following:***

 
| ** **                                                                            | ** ** | **March31,********2010** | ** ** | **December 31,********2009** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|
| ** **                                                                            | ** ** | **(in thousands)**       | ** ** |
|                                                                                  |       |                     |       |                              |       |
| $15 million IFC Senior  Note, Libor plus 2.75%, due 2012                              |       | $                        | 15,000     |                              | $          | 15,000 |   |
| $170.9  million Convertible Notes, 6.5%, due 2015, net of discount of ($34.1) million |       | 136,777                  |       | —                            |       |
| Capital  Lease Obligations                                                            |       | 10,966                   |       | 11,910                            |       |
| Other                                                                                 |       | —                   |       | 1,023                             |       |
|                                                                                  |       | 162,743                  |       | 27,933                            |       |
| Less:  Current Portion of Long-Term Debt and Capital Lease Obligations                |       | 6,912                    |       | 5,352                             |       |
|                                                                                  |       | $                        | 155,831    |                              | $          | 22,581 |   |

 

**$170.9 MillionConvertible Notes due 2015**

 

During the first quarter of 2010, the Company closedon the private offering an aggregate of $170.9 million convertible notes due2015 (the “2015 Convertible Notes”). The 2015 Convertible Notes offering wascomprised of (i) the initial $140.0 million of 2015 Convertible Notes soldin an initial private offering, (ii) the exercise by the initial purchaserof a 30- day option to purchase an additional $21.0 million of 2015 ConvertibleNotes, and (iii) IFC’s election, pursuant to a contractual right, toparticipate in the offering for an additional $9.9 million of 2015 ConvertibleNotes, bringing the total proceeds of the private offering to $170.9 million.The convertible notes were sold to an initial purchaser who then sold the notesto qualified institutional buyers pursuant to Rule 144A of the SecuritiesAct of 1933. The $170.9 million of convertible notes were issued pursuant to anindenture dated February 8, 2010, between the Company and Wells FargoBank, National Association, as trustee (“the Indenture”).

 

The 2015 Convertible Notes are the Company’s generalsenior unsecured obligations and rank equally in right of payment with all ofthe Company’s other existing and future senior unsecured indebtedness. The 2015 Convertible Notes are effectively subordinate to all of theCompany’s secured indebtedness to the extent of the value of the assetscollateralizing such indebtedness.  The 2015 Convertible Notes are notguaranteed by the Company’s subsidiaries.

 

The Company will pay interest on the 2015 ConvertibleNotes at a rate of 6.50% per year on March 1st and September 1st ofeach year, beginning on September 1, 2010.  The 2015 ConvertibleNotes mature on March 1, 2015. The initial conversion rate is 148.3856shares per $1,000 principal amount of the 2015 Convertible Notes (equal to aninitial conversion price of approximately

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

$6.74 per share of common stock), subject toadjustment. Upon conversion, the Company must deliver, at its option, either (1) anumber of shares of its common stock determined as set forth in the Indenture, (2) cash,or (3) a combination of cash and shares of its common stock (but not toexceed 19.99% of the Company’s outstanding shares at the time of suchdelivery).

 

The initial conversion rate may be adjusted on February 3,2011 if the volume weighted average price of the Company’s common stock foreach of the 30 trading days ending on February 3, 2011 is less than$5.6160 per share. In addition, following the occurrence of any one of certaincorporate transactions that constitutes a fundamental change (as defined in theIndenture), the Company will increase the conversion rate, subject to certainlimitations, for a holder who elects to convert the 2015 Convertible Notes inconnection with such corporate transactions during the 30-day period after theeffective date of such fundamental change.

 

Holders may convert their 2015 Convertible Notes attheir option at any time prior to the close of business on the second businessday immediately preceding the maturity date under the following circumstances:

 

(1) during any fiscal quarter (and only duringsuch fiscal quarter) commencing after March 31, 2010, if the last reportedsale price of the Company’s common stock is greater than or equal to 130% ofthe conversion price of the Notes for at least 20 trading days in the period of30 consecutive trading days ending on the last trading day of the precedingfiscal quarter;

 

(2) prior to January 1, 2015, during thefive business-day period after any ten consecutive trading-day period  in which the trading price of $1,000principal amount of the 2015 Convertible Notes for each trading day in themeasurement period was less than 97% of the product of the last reported saleprice of the Company’s common stock and the conversion rate on such tradingday;

 

(3) if the 2015 Convertible Notes have beencalled for redemption; or

 

(4) upon the occurrence of one of the specifiedcorporate transactions. Holders may also convert the 2015 Convertible Notes attheir option at any time beginning on February 1, 2015, and ending at theclose of business on the second business day immediately preceding the maturitydate.

 

On or after February 3, 2013, the Company mayredeem for cash all or a portion of the 2015 Convertible Notes at a redemptionprice of 100% of the principal amount of the notes to be redeemed plus anyaccrued and unpaid interest to, but not including, the redemption date, plus a “make-whole”payment if: (1) for at least 20 trading days in any consecutive 30 tradingdays ending within 5 trading days immediately before the date the Company mailsthe redemption notice, the “last reported sale price” of its common stockexceeded 175% of the conversion price in effect on that trading day, and (2) thereis no continuing default with respect to the notes that has not been cured orwaived on or before the redemption date.

 

If the Company experiences any one of the certainspecified types of corporate transactions, holders may require the Company topurchase all or a portion of their 2015 Convertible Notes. Any repurchase ofthe notes pursuant to these provisions will be for cash at a price equal to 100%of the principal amount of the notes to be purchased plus any accrued andunpaid interest to, but excluding, the purchase date.

 

The Indenture contains customary terms and covenantsand events of default. If an event of default (as defined therein) occurs andis continuing, the Trustee by notice to the Company, or the holders of at least25% in aggregate principal amount of the 2015 Convertible Notes thenoutstanding by notice to the Company and the Trustee, may declare the principaland accrued and unpaid interest (including additional interest or premium, ifany) on the 2015 Convertible Notes to be due and payable. In the case of anevent of default arising out of certain bankruptcy events (as set forth in theIndenture), the principal and accrued and unpaid interest (including additionalinterest or premium, if any), on the notes will automatically become due andpayable.

 

Net proceeds from the sale of the 2015 ConvertibleNotes, after deducting the discounts and commissions and any offering expensespayable by the Company, were approximately $164.9 million.  The initialpurchaser received commissions of approximately $5.5 million in connection withthe sale of the Notes and the Company incurred approximately $0.5 million ofdirect expenses in connection with the offering.  The Company intends touse the net proceeds for general corporate purposes, including withoutlimitation, capital expenditures and working capital, reduction or refinancingof debt, or other corporate obligations.

 

As a result of the Company’s adoption of theaccounting standard for convertible debt that may be settled in cash uponconversion, it is required to separately account for the liability and equitycomponents in a manner that reflects the Company’s non-convertible borrowing ratewhen interest cost is recognized in subsequent periods. The value assigned tothe liability component is determined by measuring the fair value of a similarliability that does not have an equity conversionfeature. The value assigned to the

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

equitycomponent is determined by deducting the fair value of the liability componentfrom the initial proceeds. The excess of the principal amount of the liabilitycomponent over its carrying amount (the non-cash discount) is amortized tointerest expense using the effective interest method over the term of the debtagreement. In addition, transaction costs incurred that directly relate to theissuance of convertible debt instruments must be allocated to the liability andequity components in proportion to the allocation of proceeds and accountedfor as debt issuance costs and equity issuance costs, respectively. Theaccounting standard requires retrospective restatement of all periods presentedback to the date of debt issuance with a cumulative effect of the change inaccounting principle on all prior periods being recognized as of the beginningof the first period.

 

The Company estimated itsnon-convertible borrowing rate at the date of issuance of its 2015 ConvertibleNotes to be 12%.  The 12% non-convertibleborrowing rate represents the borrowing rate of similar companies with the samecredit quality as the Company and was obtained through a quote from the initialpurchaser. Using the income method and discounting the principal and interestpayments of the 2015 Convertible Notes using the 12% non-convertible borrowingrate, the Company estimated the fair value of the $170.9 million 2015Convertible Notes to be approximately $136.3 million with the discount beingapproximately $34.6 million. The discount will be amortized as non-cashinterest expense into income over the life of the notes using the interestmethod. In addition, the Company recorded approximately $4.8 million of the$6.0 million of fees and commissions as debt issue costs that will be amortizedover time using the interest method as interest expense. The remaining $1.2million of fees and commissions will be treated as an original issue discountagainst the value of the equity component. The Company estimates the cashpayments related to the 2015 Convertible Notes, assuming no conversion, for theyears ended 2010, 2011, 2012, 2013, 2014 and thereafter to be approximately$6.4 million, $11.1 million, $11.1 million, $11.1 million, $11.1 million and$176.5 million, respectively.

 

As of March 31, 2010,the net amount of $136.8 million includes the $170.9 million of principalreduced by $34.1 million of the remaining unamortized discount. The net amountof the equity component is $33.4 million which includes the initial discount of$34.6 million reduced by $1.2 million of direct transaction costs. Theremaining unamortized discount of $34.1 million will be amortized into interestexpense, using the effective interest method, over the remaining life of theloan agreement, whose term expires in March 2015.  At March 31, 2010, using the currentconversion rate of 148.3856 shares per $1,000 principal amount of the 2015Convertible Notes, if the $170.9 million of principal were converted intoshares of common stock, the notes would convert into 25,364,737 shares ofcommon stock.  However, theCompany is currently limited, by NYSE rules, to issuing up to 23,031,663 shares(19.99% of the stock outstanding at the time of the issuance of the 2015Convertible Notes) in satisfaction of conversion of the 2015 Convertible Notes.Should the Company need to issue shares in excess of the 19.99% limit, it wouldneed approval by the affirmative vote of the majority of shareholders in orderto issue the shares in excess of the 19.99% limit. If $170.9 million of 2015 Convertible Noteswere converted into common stock as of March 31, 2010, using the marketprice of the Company’s common stock at March 31, 2010 of $7.35, theif-converted value in excess of the principal amount would be approximately$15.5 million.

 

For the threemonths ended March 31, 2010, the effective interest rate for the 2015Convertible Notes is 12%; including the amortization of debt issue costs, theeffective interest rate is 12.6%.  Theamount of interest expense related to 2015 Convertible Notes for the threemonths ended March 31, 2010 is $2.2 million, disregarding capitalizedinterest considerations, and includes $1.7 million of interest expense relatedto the contractual interest coupon, $0.4 million of non-cash interest expenserelated to the amortization of the discount and $0.1 million of interestexpense related to the amortization of debt issue costs.

 

**$15.0 Million IFCReserve-Based Credit Facility**

 

OnAugust 15, 2008, the Company entered into a****$15.0 million reserve-based lendingfacility (“IFC Facility”) agreement (the “Loan Agreement”) with IFC through oursubsidiaries BPZ E&P and BPZ Marine Peru S.R.L. as co-borrowers. Thereserve-based lending facility matures in December 2012.

 

The reserve-based lending facility bears interest atan approximate rate of LIBOR plus 2.75%, currently equivalent to 3.19% based onthe six month LIBOR rate of 0.44% at December 31, 2009.  The maximumamount available under this facility begins at $15.0 million and will bereduced by $2.5 million beginning on December 16, 2010 and every six monthsthereafter during the term of the Loan Agreement.  The amount availableunder the Loan Agreement is subject to a semi-annual borrowing basedetermination based on the value of oil reserves.  In addition, theCompany is subject to various financial covenants calculated as of the last dayof each quarter, including a life of field coverage ratio, life of loancoverage ratio, debt to equity ratio and interest coverage ratio. In

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

February 2010, the Company received a waiver fromIFC for the life of field coverage ratio and life of loan coverage ratio through August 2010. Additionally, theCompany requested and received a waiver and amendment from IFC which extendedthe period of time to assign a first priority lien on Empresa Electrica NuevaEsperanza S.R.L.’s interest in the Agreement with GE to purchase threegas-fired turbines to IFC until December 2010. Accordingly, the Companywas in compliance with all material covenants of the Loan Agreement as of March 31,2010.

 

The Loan Agreement provides forevents of default customary for agreements of this type, including, among otherthings, payment breaches under any of the finance documents for the first andsecond tranche of the senior debt; failure to comply with obligations;representation and warranty breaches; expropriation of the assets, business oroperations of any borrower; insolvencies of any borrower; certain attachmentsagainst the assets of any borrower; failure to maintain certain authorizationswith respect to any financing documents with the IFC, the development andoperation of the Corvina field in Block Z-1, any additional petroleum assetsunder license contracts with Perupetro S.A. (“Perupetro”), a corporationowned by the Peruvian government empowered to become a party in the contractsfor the exploration and/or exploitation of hydrocarbons in order to promotethese activities in Peru. Perupetro is empowered to enter into contracts forthe exploration and exploitation of hydrocarbons on behalf of Peru, or certain other key agreements; revocation of any financingor security documents with the IFC or certain key agreements; defaults oncertain liabilities; certain judgments against the borrower or any subsidiary;abandonment or extended business interruption of the Corvina field or certainother petroleum assets; engagement in certain sanctionable practices; orrestrictions are enacted in Peru that could inhibit any payment a borrower isrequired to make under the financing documents with the IFC.

 

If an event of default occurs, IFCand any additional facility agent may (i) terminate all or part of therelevant facility; (ii) declare all or part of the principal amount of theloan, together with accrued interest, immediately due and payable;  (iii) declareall or part of the principal amount of the loan, together with accruedinterest, payable on demand; or (iv) declare any and all of the securitydocuments under the facility enforceable and exercise its rights under suchdocuments. In addition, if any borrower is liquidated or declared bankrupt, allloans and interest accrued on it or any other amounts due, will becomeimmediately due and payable without notice.

 

**Other**

 

In July 2009, theCompany, through its subsidiary, BPZ E&P, entered into a $5.1 millionshort-term loan agreement to finance the purchase of casing and accessories foruse in its current and future operations. The $5.1 million short-term loan borean annual interest rate of 5.45% and was to be repaid in five monthlyinstallments of approximately $1.0 million starting September 2009. In connection with the $5.1 million short-term loan agreement, the Companywas  required to deposit $1.0 millionwith the lending institution as a guaranty for the loan.  The $1.0 millionwas to be applied to the last installment of the loan repayments. In January 2010,the remaining principal amount of approximately $1.0 million and, along withthe accrued interest due, was repaid with the $1.0 million deposit and cash.

 

**Capital Leases**

 

The Company is party to several capital leaseagreements, as more fully described in its Form 10-K, as amended, for theyear ended December 31, 2009. Generally, the Company enters into capital lease agreements in order tosecure marine vessels in order to support its operations in Peru and to obtainfurniture and fixtures for its offices located in Houston and Peru. Thecontractual term of the capital lease agreements range between two to fiveyears and the effective interest rate of the capital lease agreements rangebetween 5.94% and 34.9%.

 

For the three monthsended March 31, 2010, the Company recognized approximately $1.9 million ofnet interest expense which includes $3.3 million of interest expense reduced by$1.4 million of capitalized interest expense. For the same period in 2009, theCompany did not recognize any interest expense as it capitalized all interestexpense of $0.9 million to construction in progress.

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

**Note10 — Stockholders’ Equity**

 

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

 

**September 2009 Private Placementof Common Stock**

 

On September 15, 2009, the Company closed aprivate placement of approximately 1.6 million shares of common stock, no parvalue, to IFC pursuant to a Subscription Agreement dated September 15,2009. This private placement was related to the Company’s registered directoffering of approximately 18.8 million shares of Common Stock at a price of$4.66 per share that closed on June 30, 2009. Pursuant to the SubscriptionAgreement dated December 16, 2006 (the “Subscription Agreement”) by andbetween IFC and the Company, IFC has the right, within 45 days of notice of theoffering, to purchase shares of the Company’s Common Stock for the same priceand terms as the participants in an offering to retain its proportionate ownershipin the Company. IFC exercised its pre-emptive right to purchase approximately1.6 million shares of Common Stock at the offering price of $4.66 per share towhich it was entitled under the Subscription Agreement, resulting in grossproceeds to the Company of approximately $7.6 million. The transaction wassubmitted to and approved by the shareholders of the Company at a SpecialMeeting of Shareholders on August 24, 2009. No warrants or dilutivesecurities were issued to IFC in connection with the private placement. Theshares were placed directly by the Company. The Company used the proceeds ofthis offering to develop its properties under its existing license contractsand other general corporate purposes consistent with the Company’s operatingplans.

 

Under the September 15, 2009 SubscriptionAgreement, the Company committed to file a registration statement with the Securities andExchange Commission (“SEC”) covering the shares no later than 45 days after theclosing with respect to such shares, and will use its reasonable best effortsto obtain its effectiveness no later than the earlier of (i) 90 days afterthe closing with respect to such shares, or in the event of SEC review of theregistration statement, 120 days after the closing and (ii) the thirdbusiness day following the date on which the Company is notified (orally or inwriting, whichever is earlier) by the SEC that the registration statement willnot be reviewed or is no longer subject to further review and comment unless,upon the advice of legal counsel, it is advisable not to accelerate theeffectiveness of such registration statement. On October 21, 2009, theCompany filed a registration statement with the SEC covering the shares.

 

Subsequently, the Company received comments from theSEC pertaining to its registration statement, Form 10-K for the year endedDecember 31, 2008, Definitive Proxy Statement filed on April 30,2009, Form 10-Q for the period ended September 30, 2009 and therelated earnings press release. The Company promptly responded to the SEC’srequests and, where appropriate, made clarifications to its disclosures. In May 2010the Company filed an amended registration statement with the SEC and expectsthe amended registration statement will be declared effective later in May 2010.There are no penalty payments associated with the delay in obtainingeffectiveness of the registration statement.

 

**Potentially Dilutive Securities**

 

In addition to the shares issued and outstanding, the Company has the following potentially dilutive securities at March 31, 2010 and March 31, 2009.  None of these potentially dilutive shares have been included in the calculation of earnings per share, for the three months ended March 31, 2010 or March 31, 2009, as the effect would be anti-dilutive.

 

The potentially dilutive shares are as follows:

 
| ** **                                                           | ** ** | **March 31,********2010** | ** ** | **March 31,********2009** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                                           | ** ** | **(in thousands)**             | ** ** |
| Stock  options outstanding                                           |       | 4,545                          |       | 3,894                          |       |
| Shares  issuable under convertible debt agreement                    |       | 25,365                         |       | —                         |       |
| Total  potentially dilutive securities issued                        |       | 29,910                         |       | 3,894                          |       |
|                                                                 |       |                           |       |                           |       |
| Shares  available pursuant to Long-Term Incentive Compensation Plans |       | 1,539                          |       | 2,541                          |       |

 

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**BPZResources, Inc. and Subsidiaries**

**NotesTo Consolidated Financial Statements**

**(Unaudited)**

 

The Company has in effectthe 2007 Long-Term Incentive Compensation Plan (the “2007 LTIP”) and the 2007Directors’ Compensation Incentive Plan (the “Directors’ Plan”). The 2007 LTIPand Directors’ Plan provides for awards of options, stock appreciation rights,restricted stock, restricted stock units, performance awards, other stock-basedawards and cash-based awards to any of the Company’s officers, employees,consultants and the employees of certain of the Company’s affiliates as well asnon-employee directors. The number of shares authorized under the 2007 LTIP andDirectors’ Plan is 4.0 million and 2.5 million, respectively. As of March 31,2010, 163,900 sharesremain available for future grants under the 2007 LTIP and 1,375,000 sharesremain available for future grants under the Directors’ Plan.

 

Thefollowing table summarizes stock-based compensation costs recognized under ASCTopic 718, “Stock Compensation” for the three months ended March 31, 2010and 2009, respectively, and is generally included in “General andadministrative expense” on the Consolidated Statements of Operations:

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **March 31,**               | ** ** |
| ** **                                    | ** ** | **2010**                         | ** ** | **2009** | ** ** |
| ** **                                    | ** ** | **(in thousands)**               | ** ** |
| Employee  stock—based compensation costs |       | $                                | 1,306      |   | $ | 1,348 |   |
| Director  stock—based compensation costs |       | 550                              |       | 1,926 |   |
|                                          |       | $                                | 1,856      |   | $ | 3,274 |   |

 

**Note 11**—******Fair Value Measurementsand Disclosures**

 

The Company recordscertain of its assets and liabilities on the balance sheet at fair value. Fairvalue is defined as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date (exit price). A three-level valuation hierarchy hasbeen established to allow readers to understand the transparency of inputs tothe valuation of an asset or liability as of the measurement date. The threelevels are defined as follows:

 
| · | Level 1 — | Fair value measurements  which use quoted market prices (unadjusted) in active markets for identical  assets or liabilities.                                                  |
|--------|----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |           |                                                                                                                                                                          |
| · | Level 2 — | Fair value measurements  which use inputs, other than quoted prices included within Level 1, which are  observable for the asset or liability, either directly or indirectly. |
|   |           |                                                                                                                                                                          |
| · | Level 3 — | Fair value measurements  which use unobservable inputs.                                                                                                                       |

 

The following describesthe valuation methodologies the Company uses for its fair value measurements.

 

**Assetsand Liabilities Measured at Fair Value on a Recurring Basis**

 

*Cashand cash equivalents*

 

Cash and cash equivalentsinclude all cash balances and any highly liquid investments with an originalmaturity of 90 days or less. The carrying amount approximates fair valuebecause of the short maturity of these instruments.

 

*RestrictedCash*

 

Restricted cash includesall cash balances which are classified as long-term as they are associated withthe Company’s long-term assets. The carrying amount approximates fair value becausethe nature of the restricted cash balance is the same as cash.

 

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**BPZ Resources, Inc. and Subsidiaries**

**Notes To Consolidated Financial Statements**

**(Unaudited)**

 

**Non-FinancialAssets and Liabilities**

 

The Company discloses or recognizes its non-financial assets andliabilities, such as asset retirement obligations and impairments of long-livedassets, at fair value on a nonrecurring basis. As none of the Company’snon-financial assets and liabilities were impaired as of March 31, 2010and December 31, 2009, and no other fair value measurements were requiredto be recognized on a non-recurring basis, additional disclosures were notprovided.

 

**AdditionalFair Value Disclosures**

 

*$15.0Million IFC Reserve-Based Credit Facility*

 

The fair value of the Company’s IFC Facility at March 31,2010 and December 31, 2009 approximates the carrying value because theinterest rates are based on floating rates identified by reference to marketrates, and because the interest rates charged are at rates at which the Companycan currently borrow under similar terms.

 

The fair valueinformation regarding our fixed rate debt is as follows:

 
| ** **                                                                                 | ** ** | **March 31,********2010** | ** ** | **December 31,********2009** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                 | ** ** | **Carrying Amount**            | ** ** | **Fair Value (2)**                | ** ** | **Carrying Amount** | ** ** | **Fair Value** | ** ** |
| ** **                                                                                 | ** ** | **(in thousands)**             | ** ** | **(in thousands)**                | ** ** |
| $170.9  million Convertible Notes, 6.5%, due 2015, net of discount of ($34.1) million  (1) |       | $                              | 136,777    |                              | $          | 136,777 |   | $ | — |   | $ | — |   |
|                                                                                            |            |                                |            |                                   |            |  |  |  |  |  |  |  |  |

 

----

(1)      Excludes obligations under capital lease arrangementsand variable rate debt

 

(2)      The Company estimated the fair value ofthe $170.9 million 2015 Convertible Notes to be approximately $136.3 millionwith the unamortized discount being approximately $34.6 million using theincome method and discounting the principal and interest payments of the 2015Convertible Notes using a 12% non-convertible borrowing rate. The 12%non-convertible borrowing rate represents the borrowing rate of similarcompanies with the same credit quality as the Company and was obtained througha quote from the initial purchaser. The interest rate used in the income methodrepresents a level 3 input.

 

**Note 12**—**Revenue**

 

At March 31, 2010,the Company is currently producing oil from six wells in the Corvina field andone well in the Albacora field under a well testing program.

 

The Corvina oil isdelivered by barge to the Petroleos del Peru - PETROPERU S.A. ((“Petroperu”) a private law state companyengaged in the refining, transportation, distribution and trading of petroleumproducts to meet Peru’s domestic energy needs) refinery in Talara, located approximately 70miles south of the platform.  Produced oil is kept in production inventoryuntil the Company increases the inventory quantities to a sufficient level thatthe refinery in Talara will accept delivery.

 

In January 2009, theCompany, through its wholly-owned subsidiary BPZ E&P, entered into along-term oil supply agreement with Petroperu. Under the terms of the contract,the Company agrees to sell, and Petroperu agrees to purchase the Company’scrude oil production originating from the Corvina oilfield in Block Z-1. Thecontract term is for approximately seven years or until 17 million barrels ofcrude oil have been delivered to the Petroperu refinery located in Talara,whichever comes first. The price per barrel of oil under the agreement isdetermined using a basket of crude oils based on a 15-day average of Forties,Oman, and Suez blend crude oil prices, as quoted in the Spot Crude PricesAssessment published in Platt’s Crude Oilgram Price Report, minus $1 per barreland other customary purchase price adjustments. The Company is currently innegotiations with Petroperu and

 

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**BPZ Resources, Inc. and Subsidiaries**

**Notes To Consolidated Financial Statements**

**(Unaudited)**

 

other interested parties to finalize a short-term oilsales contract for up to 400,000 barrels of oil originating from the Albacorafield.

 

During the three monthsended March 31, 2010 and 2009, the Company produced approximately 458,620 and 355,175barrels of oil, respectively.  For the three months ended March 31,2010 and 2009, theCompany sold 343,315 and 330,847 barrels of oil at an average per barrel price,net of royalties, of approximately $70.04, and $39.97, respectively.

 

The Company’s revenuesare reported net of royalties owed to the government of Peru. Royalties areassessed by Perupetro as stipulated in the Block Z-1 license agreement based onproduction. However their calculation is based on the past five-day averagebasket of crude oils prices, as discussed above, before the crude oil deliverydate. For the three months ended March 31, 2010 and 2009, the revenues received by the Companyare net of royalty costs of approximately 5% and 6% of gross revenues or $1.3million and $0.8 million, respectively.

** **

**Note 13 — Income Tax**

** **

For the three monthsended March 31, 2010, the Company recognized an income tax expense ofapproximately $1.1 million on a net loss before income tax of approximately$0.7 million.  For the same period in2009, the Company recognized an income tax benefit of approximately $1.2million on a net loss before income tax of approximately $8.3 million.  The difference between the effective tax raterecognized and the 22% statutory rate provided for under the Block Z-1 LicenseContract is largely due to:

 

·      The Company has a 100% allowance on itsnet operating losses generated in the United States  —  TheCompany has a valuation allowance for the full amount of the domestic deferredtax asset resulting from the income tax benefit generated from net losses inthe U.S., as it believes, based on the weight of available evidence, that it ismore likely than not that the deferred tax asset will not be realized prior tothe expiration of net operating loss carryforwards in various amounts through2027.

 

·      Certain U.S. expenses are not deductiblein Peru - The tax benefit is based on a taxable Peruvian loss that excludescertain U.S. expenses that are not deductible at the Peruvian level.

 

Estimated interest andpenalties related to potential underpayment on unrecognized tax benefits, ifany, are classified as a component of tax expense in the Consolidated Statementof Operations. For the three months ended March 31, 2010 and 2009,respectively, the Company did not have any accrued interest or penaltiesassociated with any unrecognized tax benefits, nor was any interest expenserecognized during those periods.

 

**Note 14 — Business Segment Information**

 

The Company determinesand discloses its segments in accordance with ASC Topic 280, “Segment Reporting”(“ASC Topic 280”), previously in accordance with SFAS No. 131 “Disclosuresabout Segments of an Enterprise and Related Information”,  which uses a “management”approach for determining segments. The management approach designates theinternal organization that is used by management for making operating decisionsand assessing parlance as the source of the Company’s reportable segments. ASCTopic 280 also requires disclosures about products or services, geographicareas, and major customers. The Company’s management reporting structureprovided for only one segment for the three months ended March 31, 2010and March 31, 2009 and accordingly, no separate segment information ispresented. In addition, the Company operates only in Peru and has only onecustomer for its oil production, Petroperu. The majority of the Company’slong-lived assets are located in Peru.

 

**Note 15 — Commitments and Contingencies**

 

*Extended Well Testing Program*

 

On December 13, 2009new legislation regulating extended well testing in Peru became effective undera Supreme Decree.  The new regulation provides that all new wells may beplaced on production testing for up to six months.  If the operatorbelieves that additional time for testing is needed to properly evaluate theproductive capacity of the field, and can technically justify such need, arequest for the well to enter into an Extended Well Test (“EWT”) period must besubmitted to the General Directorate of Hydrocarbons (“DGH”), the agency of theMinistry of Energy and Mines responsible for regulating the optimum developmentof oil and gas fields.  The approval process for an EWT permit requiresthat the DGH request Perupetro’s opinion on the technical justification for theEWT.  After the initial six month period or after an approved EWT programexpires, the operator will be required

 

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**BPZ Resources, Inc. and Subsidiaries**

**Notes To Consolidated Financial Statements**

**(Unaudited)**

 

to have the necessary gas and water reinjectionequipment in place to continue producing the well according to existingenvironmental regulations.  For wells that have been under testing formore than six months as of the date of publication of the Supreme Decree, thenew regulation provides 30 business days to apply to the DGH for thecorresponding EWT permit.  Additionally,during both the initial six month testing period and any extended period thatmay be granted, the Company must also obtain gas flaring permits for each wellin order for it to be in compliance with Peruvian legislation regulatingwell testing.

 

On December 29,2009, the Company received approval from Perupetro of its proposed First Dateof Commercial Production (“FDCP”), as set forth in the current FieldDevelopment Plan (“FDP”) for the Corvina field in Block Z-1, which is May 31,2010.

 

On January 25, 2010,the Company applied for an extended well testing permit in Corvina for thefirst five wells (the CX11-21XD, CX11-14D, CX11-20XD, CX11-18XD and theCX11-15D wells, collectively the “first five wells” or “five Corvina wells”)as it believes it is necessary to continue gathering data to fullyunderstand the drive mechanisms that are present in Corvina.  On March 23,2010, the Company received a decision from the DGH notifying it that they areapproving BPZ to continue extended well testing on its first five Corvina wellsuntil the FDCP date of May 31, 2010, subject to specific limits on theamount of natural gas flared from each of the first five Corvina wells. Basedon the natural gas flaring limits set by the DGH, the Company has constrainedthe oil production from those five Corvina wells in order to comply with thoselimits. The actual future decrease in production from these five Corvina wellswill not be known until the Company fully implements its gas flaring mitigationstrategy to optimize oil production while complying with the gas flaringlimits, but the Company estimates the production from these wells has decreasedby approximately 650 bopd compared to the production of these wells during thefourth quarter of 2009.  Additionally,the Company estimates that production from these wells could continue to bedecreased by as much as 400 to 800 bopd.

 

TheCompany initially planned to have the needed gas and water re-injectionfacilities at the CX-11 platform by the approved FDCP of May 31,2010.  However, this no longer appears tobe achievable due to the delayed delivery of certain equipment. If the Companyis unable to receive and install the necessary gas and water reinjectionequipment and receive approval of the corresponding environmental permits by May 31,2010, it may not be permitted to produce from some or all of the oil wells inCorvina until such installation is completed or an extension of the May 31,2010 date is obtained.  The Company has applied to the properauthorities for an extension of the May 31, 2010 date to be able tomaintain testing the wells in Corvina; however, no assurance can be given thatsuch extension will be awarded.  Depending on the extent of the delay, theCompany plans to use the additional time to drill one or two more wells fromthe CX-11 platform after the current well, the CX11-22D is completed.  Further, the Company may not be able toproduce any well drilled after December 13, 2009 for a period longer thanthe initial six month testing period. The Company’s current view is that it maybe able to produce its new wells CX11-17D, CX11-19D, CX11-22D, and any otherwell drilled at the CX-11 platform for at least six months, as stated by thenew well testing regulations.  Testingthese wells beyond the initial six month period will require a specialapplication to the Ministry of Energy and Mines, who may not grant approval.

 

In addition, the Company is in the initial stages ofappraising, exploring and developing its potential oil and natural gas reservesin the Albacora field of Block Z-1.  TheCompany’s first well in Albacora has been, and all new wells drilled inAlbacora will be, placed in the initial six-month production testing under thenew legislation.  As in Corvina, theCompany will need to receive approval for all the pertinent environmental andtechnical permits and install the required gas and water reinjection facilitiesat the Albacora platform in order to transition from exploration to commercialproduction, which as currently estimated could take up to two years.  If the Company does not receive EWT permitson wells in Albacora beyond the original six-month test period, it willexperience an interruption in production that would negatively impact anyrevenue and cash flow associated with those wells until the applicablerequirements are satisfied for commercial production.

 

*SEC Comments*

 

In connection with a registration statement filed on October 21,2009 to register shares issued to IFC in a private transaction, theCompany received comments from the SEC pertaining to its registrationstatement,  Form 10-K for the yearended December 31,2008, Definitive Proxy Statement filed on April 30,2009, and Form 10-Q for the period ended September 30, 2009 and the

 

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**BPZ Resources, Inc. and Subsidiaries**

**Notes To Consolidated Financial Statements**

**(Unaudited)**

 

related earnings press release. In general, thequestions or comments from the SEC related to: (i) clarifications inseveral of the Company’s disclosures; (ii) the basis for the assumptionsunderlying its SEC oil reserves reported for 2008 in light of its actualproduction performance in 2009; (iii) the reasons its 2009 production fellshort of 2008 projections; (iv) the consideration the Company  gave to the reasonable certainty of its assumptionsunderlying its SEC oil reserves and the related accounting reported in itsfinancial statements; and (v) how the Company is taking into considerationcertain items and uncertainties for its 2009 reserves report. The Company  promptly responded to the SEC’s requests and,where appropriate, made clarifications to its disclosures. On April 14,2010, the SEC notified the Company that they had no further comments at thattime.

 

*Profit Sharing*

 

TheConstitution of Peru and Legislative Decree Nos. 677 and 892 gives Peruemployees working in private companies engaged in activities generating incomeclassified as third category income by the Income Tax Law the right to share inthe Company’s Peruvian subsidiaries’ profits. According to Article 3 ofthe United Nations International Standard Industrial Classification, BPZE&P’s tax category is classified under the “mining companies” section,which sets the rate at 8%. However, in Peru, the Hydrocarbons’ Law states, andthe Supreme Court ruled, that hydrocarbons are not related to miningactivities. Hydrocarbons are included under “Companies Performing otherActivities”, thus Oil and Gas Companies pay profit sharing at a rate of 5%. The5% of income is determined by calculating a percentage of the Company’s Peruviansubsidiaries’ annual total revenues subject to income tax less the expensesrequired to produce revenue or maintain the source of revenues. The benefitgranted by the law to employees is calculated on the basis of “income subjectto taxation” per the Peruvian tax code, and not based on income/(loss) beforeincomes taxes as reported under GAAP. For the three months ended March 31,2010 and 2009, approximately$0.9 million and $0.3 million of expense related to profit sharing is included in “General andadministrative expense” in the Consolidated Statement of Operations as theCompany’s Peruvian subsidiaries have “income subject to taxation” per thePeruvian tax code.  The Companywill be subject to profit sharing expense each year its Peruvian subsidiariesare considered profitable under the Peruvian tax code.

 

*Barge Incident*

 

In August 2006, theCompany incurred an operational delay resulting from a navigation incidentwhich caused the BPZ-01 barge to be grounded on a sand bar in Talara Bay innorthwest Peru.  The Company expects to file an insurance claim after thedry docking of the vessel.  The dry dock of the BPZ-01 is scheduled duringthe third quarter of 2010.  As of March 31, 2010, the Company has notpresented a final claim to its insurance carrier for the barge repairs.

 

The Company believes themajority of the costs associated with the grounding incident will be reimbursedthrough insurance or through a third party.  No assurances can be given,however, that any such recoveries will be sufficient to cover all costsassociated with the incident or to the timing of any such recoveries.  TheCompany intends to file an insurance claim with its underwriters after it hasfully assessed the damages and estimated repair costs as well as finalized thereimbursement agreement with the third party.

 

*Peru Properties*

 

As of March 31, 2010, the Company has restrictedcash deposits of $5.5 million. In connection with the Company’s properties inPeru, it obtained four performance bonds totaling $5.3 million that arepartially collateralized by restricted cash deposits of $3.1 million to insurecertain performance obligations and commitments under the license contracts forBlocks Z-1, XIX, XXII and XXIII. Additionally, the Company has $2.4 million ofrestricted cash to collateralize insurance bonds for import duties related tothe BPZ-01 barge and crane on board the BPZ-01 and  an unsecured performance bond of $0.1 millionto guarantee its performance under an office lease agreement in Peru.

 

*GE Turbine Purchase Agreement**,**Amendment and LetterAgreement*

 

On September 26,2008, the Company, through its subsidiary Empresa Electrica Nueva EsperanzaS.R.L., entered into a $51.5 million contract (the “Agreement”) for thepurchase of three LM6000 gas-fired turbines from GE Packaged Power, Inc.and GE International, Inc. Sucursal de Peru (collectively “GE”). TheAgreement required an initial down payment of $5.1 million and monthly progresspayments of $1.1 million per unit. In January 2009, BPZ and GE enteredinto an amendment of the contract. Under the terms of the amendment, both GEand BPZ agreed to a suspension period under the Agreement from and including December 15,2008 through November 15, 2009, whereby no failure on the part of BPZ orGE to perform any obligations under the Agreement would give rise to a breachof contract or the right to terminate the contract, provided the Company make a$3.4 million progress payment no later than February 25, 2009, and a $3.5million progress payment to GE no later than November 16, 2009. On February 24,2009, the Company paid the first progress payment of $3.4 million. The Companywas still in negotiations with GE to modify the terms of the

 

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**BPZ Resources, Inc. and Subsidiaries**

**Notes To Consolidated Financial Statements**

**(Unaudited)**

 

Agreement at the time the second progress payment wasdue on November 16, 2009, and GE agreed to a short extension of thedeadline for the milestone payment in order to conclude ongoing negotiationswith respect to new delivery dates, pricing, payment terms and payment securityfor the reinstatement of the Agreement. Amended terms were agreed with GE byLetter Agreement on November 20, 2009, at which time the Company made the$3.5 million progress payment. Under the terms of the Letter Agreement, GE andBPZ agreed to a variable monthly payment plan with a final $20.7 millionpayment due December 1, 2010.  Additionally,should the Company locate a joint venture partner and obtain financing for thethree LM6000 gas-fired turbines and services prior to the December 1, 2010deadline, the Company agrees to pay the final payment under the LetterAgreement within 7 days of obtaining the financing and funding.

 

Should the Company notmake the payments in accordance with the terms of the Letter Agreement, thiswould result in immediate termination of the Agreement without any additionalnotice or cure period. As of March 31, 2010, the Company has made paymentsto GE totaling $19.0 million. Additionally, through May 10, 2010 theCompany made additional payments of $1.0 million and plans to meet theremaining payments due throughout 2010 by using proceeds of the recent convertibledebt offering or subsequent project financing. Failure to make any of theremaining progress payments in full would result in a charge-off of all of thepreviously made progress payments.

 

*Gas-to-Power Project Financing*

 

The Corvina gas-to-powerproject entails the installation of a 10-mile gas pipeline from the CX-11platform to shore, the construction of gas processing facilities and thebuilding of an approximately 135 megawatt (“MW”) simple-cycle electricgenerating plant.  Theproposed power plant site is located adjacent to anexisting substation and power transmission lines which, after the Peruviangovernment completes their expansion, are expected to be capable of handling upto 320 MW of power. The existing substation and transmission lines are ownedand operated by third parties.

 

The Company currentlyestimates the gas-to-power project will cost approximately $150.0 million,excluding 19% value-added tax which will be recovered via early recovery and/orfuture revenue billings.  The $150.0 million includes $130.0 million forthe estimated cost of the power plant and $20.0 million for the estimated costof the construction of the natural gas pipeline. While the Company hasidentified and held discussions with several potential joint venture partnersfor the gas-to-power project in an attempt to secure additional equity for theproject, the Company has not entered into any definitive agreements with apotential partner. In the event the Company is able to reach an agreement witha potential joint venture partner, it may only retain a minority position inthe project. However, the Company expects to retain the responsibility for theconstruction of the pipeline as well as retain ownership of the pipeline. Ifthe Company is unable to reach an agreement with a potential partner, theCompany plans to continue moving the project forward to completion without apartner. The Company is currently in the process of identifying and securingthe additional financing necessary to move the project forward, if a suitablejoint venture partner is not identified.

 

**Note 16 — Legal Proceedings**

 

*Navy Tanker Litigation*

 

On October 24, 2007, Tecnomarine SAC, acontractor to BPZ E&P, entered into two short-term agreements with thePeruvian Navy’s commercial branch to charter two small tankers for use in theCompany’s offshore oil production operation.  On January 30, 2008,one of the tankers, the Supe, sank after catching fire. Neither of thePeruvian governmental agencies charged with investigating the incident found faultwith Tecnomarine SAC or the Company’s subsidiary, BPZ E&P. A lawsuit wasnonetheless filed in the 152nd Judicial District Court of Harris County, Texasby two crewmembers and the family and estate of two deceased sailors injured inthe incident, claiming negligence and gross negligence on the part of BPZResources, Inc. and BPZ Energy LLC., parent entities of BPZ E&P, thatwere not parties to the charter operation.  Based on the Company’sassessment of the available facts, including the fact that none of the Peruviangovernment-sanctioned investigations into the Supe incident found fault on thepart of Tecnomarine or BPZ E&P, the Company does not believe the outcome ofthe legal proceeding will have a material adverse effect on its financial condition,results of operations or cash flows. The Company intends to vigorously defendthis action but cautions that there is inherent risk in litigation, which isdifficult to quantify, especially at the early stage of litigationproceedings.   In any event, the Company believes that any monetarydamages arising from the incident would be adequately covered by its insurancepolicies, after a customary deductible.

 

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**BPZ Resources, Inc. and Subsidiaries**

**Notes To Consolidated Financial Statements**

**(Unaudited)**

 

**Note 17 — Subsequent Events**

 

Subsequentto March 31, 2010, the Company received notification of the status of theSEC comments.  For further informationsee Note 15, “Commitments and Contingencies”.

 

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

 

**Overview**

 

You should read the following discussion andanalysis together with our consolidated financial statements and notes theretoand the discussion contained in Item 7. “Management’s Discussion and Analysisof Financial Condition and Results of Operations,” Item 7A, “Quantitative andQualitative Disclosures About Market Risk” and Item 1A.  “RiskFactors” included in our Annual Report on Form 10-K, as amended, for the year ended December 31,2009.  The following information containsforward-looking statements that involve risks, uncertainties andassumptions.  Should one or more of theserisks or uncertainties materialize, our actual results may differ from thoseexpressed or implied by the forward-looking statements.  See “Disclosure Regarding Forward-LookingStatements” below.

 

BPZ Resources, Inc., a Texas corporation, is based in Houston,Texas with offices in Lima, Peru and Quito, Ecuador. We are focused on theexploration, development and production of oil and natural gas in Peru and to alesser extent Ecuador. We also intend to utilize part of our planned futurenatural gas production as a supply source for the complementary development ofa gas-fired power generation facility in Peru which we expect to wholly orpartially own.

 

We maintain a subsidiary, BPZ Exploración & Producción S.R.L.(“BPZ E&P”),  registered in Peru through our wholly-owned subsidiaryBPZ Energy International Holdings, L.P., a British Virgin Islands limitedpartnership, and its subsidiary BPZ Energy, LLC, a Texas limited liabilitycompany. Currently, we, through BPZ E&P, have exclusive rights and licensecontracts for oil and gas exploration and production covering a total ofapproximately 2.2 million acres, in four blocks, in northwest Peru. Our licensecontracts cover 100% ownership of the following properties: Block Z-1 (0.6million acres), Block XIX (0.5 million acres), Block XXII (0.9 million acres)and Block XXIII (0.2 million acres). The Block Z-1 contract was signed in November 2001,the Block XIX contract was signed in December 2003 and Blocks XXII andXXIII contracts were signed in November 2007. Generally, according to theOrganic Hydrocarbon Law No. 26221 and the regulations thereunder (the “OrganicHydrocarbon Law” or “Hydrocarbon Law”) the seven-year term for the explorationphase can be extended in each contract by an additional three years up to amaximum of ten years. However, specific provisions of each license contract canvary the exploration phase of the contract as established by the Hydrocarbon Law.The license contracts require us to conduct specified activities in therespective blocks during each exploration period in the exploration phase. Ifthe exploration activities are successful, we may decide to enter theexploitation phase and our total contract term can extend up to 30 years foroil exploration and production and up to 40 years for gas exploration andproduction. In the event a block contains both oil and gas, as is the case inour Block Z-1, the 40-year term may apply to oil exploration and production aswell.

 

Additionally, through our wholly-owned subsidiary, SMC Ecuador Inc., aDelaware corporation, and its registered branch in Ecuador, we own a 10%non-operating working interest in an oil and gas producing property, Block 2,located in the southwest region of Ecuador (the “Santa Elena Property”). Thelicense agreement covering the property extends through May 2016.

 

We are in the process of developing our oil and natural gas reserves.We have been producing and selling oil from the CX-11 platform in the Corvinafield of Block Z-1 under a well testing program and are in the process ofsatisfying the conditions to transition to commercial production in Corvina.  We are also in the initial stages ofappraising, exploring and developing our potential oil and natural gas reservesfrom the A platform in the Albacora field of Block Z-1 and have drilled andcompleted our first well in December 2009. From the time we began producing from the CX-11 platform in the Corvinafield in November 2007 and the Albacora field in December 2009,through March 31, 2010, we have produced approximately 2.3 million barrelsof oil. Additionally, our activities in Peru include analysis and evaluation oftechnical data on our other properties, preparation of the development plansfor the properties, refurbishment of and designs for platforms to perform ourdrilling campaigns in the Corvina and Albacora fields in Block Z-1, procuringmachinery and equipment for an extended drilling campaign, obtaining allnecessary environmental and operating permits, bringing additional productionon-line, seismic acquisition, obtaining detailed engineering and design of thepower plant and gas processing facilities, executing a contract to purchasethree LM 6000 gas-fired turbines and securing the required capital andfinancing to conduct the current plan of operation.

 

At December 31, 2009, we had estimated net proved oil reserves of37.5 MMBbls, of which 27.5 MMBbls were in the Corvina field and 10.0MMBbls were from the Albacora field; both fields being in Block Z-1, locatedoffshore of northwest Peru. Of our total proved reserves, 9.9 MMBbls(26.4%) are classified as proved developed reserves consisting of 10 wellsand 27.6 MMBbls (73.6%) are classified as proved undeveloped reservesconsisting of 22 future wells. The process of estimating oil and naturalgas reserves is complex and requires many assumptions that may turn out to beinaccurate.

 

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Our current activities and related planning arefocused on the following objectives:

 

·          Transition of the Corvina field in Block Z-1 fromextended well testing to commercial production, which involves the installationof equipment necessary to comply with Peruvian environmental and otherregulatory requirements;

 

·          Development of the Albacora field in Block Z-1 wherewe have commenced drilling and begun initial production well testing. We willalso need to install equipment in Albacora as necessary to comply with Peruvianenvironmental regulations and are planning on an approximately two-year periodto transition to commercial production;

 

·          Continued development of our gas-to-power project tomonetize our natural gas reserves, which we have identified in Corvina, but forwhich no market has yet otherwise developed, preventing us from reportingvolumes of gas reserves for Securities and Exchange (“SEC”) reporting purposes;

 

·          Continued acquisition of seismic and well testing datato better understand the characteristic and potential of our license propertiesand build our reportable asset values;

 

·          Commencement of an on-shore drilling campaign todevelop our on-shore properties and meet our applicable license requirements;and

 

·          Securing the required capital and financing to conductthe current plan of operation.

 

Wehave determined our reporting structure provides for only one operating segmentas we currently only operate in Peru and currently have only one customer forour production.

 

**Our Business Plan**

 

Our business plan is to enhance shareholder value primarily throughapplication of our knowledge of our targeted areas in Peru and leveragingmanagement’s experience with the local suppliers and regulatory authorities toeffectively and efficiently (i) quantify the potential value of our oiland gas holdings in Peru; (ii) increase production and cash flows from ouridentified holdings; and (iii) create a revenue stream throughimplementation of our gas-to-power project, thus increasing shareholder value.

 

Our management team has extensive engineering, geological, geophysical,technical and operational experience and extensive knowledge of internationaloil and gas operations throughout Latin America and in particular, Peru.

 

Our focus is to re-appraise and develop properties in northwest Peruthat have been explored by other companies and have reservoirs that appear tocontain commercially productive quantities of oil and gas, as well as otherareas that have geological formations that we believe potentially containcommercial amounts of hydrocarbons. Additionally, we are advancing ourgas-to-power project to monetize our future natural gas production.

 

Two of the four blocks (Block Z-1 and Block XXIII) contain structuresdrilled by previous operators who encountered hydrocarbons. However, at thetime the wells were drilled, the operators did not consider it economicallyfeasible to produce those hydrocarbons.  Having found oil in our firstwell in the Corvina field in offshore Block Z-1 in 2007, and oil in our firstwell in Albacora in December 2009, we are focusing on development of theproved oil reserves in the Corvina and Albacora fields.

 

In addition, our business plan includes a gas-to-power project, whichentails the installation of a 10-mile gas pipeline from the CX-11 platform toshore, the construction of gas processing facilities and the building of anapproximately 135 megawatt (“MW”) simple cycle electric generating plant usingthree LM 6000 gas-fired turbines. The proposed power plant site is locatedadjacent to an existing substation and power transmission lines which, withcertain upgrades, are expected to be capable of handling up to 320 MW of power.The gas-to-power project will allow us to create a revenue stream by creating amarket for the gas discovered in our Corvina field that is currentlyshut-in.  We plan to utilize part of ourfuture natural gas production as a supply source for the development of agas-fired power generation facility in Peru, which we currently plan to whollyor partially own. This project has not yet been financed and we continue toconsider the best financing alternatives for the project, including a possiblejoint venture partner.

 

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**Extended Well Testing Program**

 

On December 13, 2009 new legislation regulating well testing inPeru became effective under a Supreme Decree.  The new regulation providesthat all new wells may be placed on production testing for up to sixmonths.  If the operator believes that additional time for testing isneeded to properly evaluate the productive capacity of the field, and cantechnically justify such need, a request for the well to enter into an ExtendedWell Test (“EWT”) period must be submitted to the General Directorate ofHydrocarbons (“DGH”), the agency of the Ministry of Energy and Minesresponsible for regulating the optimum development of oil and gas fields. The approval process for an EWT permit requires that the DGH request Perupetro’sopinion on the technical justification for the EWT.  After the initial sixmonth period or after an approved EWT program expires, the operator will berequired to have the necessary gas and water reinjection equipment in place tocontinue producing the well according to existing environmentalregulations.  For wells that have been under testing for more than sixmonths as of the date of publication of the Supreme Decree, the new regulationprovides 30 business days to apply to the DGH for the corresponding EWT permit.Additionally, during both the initial six month testing period and any extendedperiod that may be granted, we must also obtain gas flaring permits for eachwell in order for us to be in compliance with Peruvian legislationregulating well testing.

 

On December 29,2009, we received approval, from Perupetro, of our proposed first date ofcommercial production (“FDCP”), as set forth in the current field developmentplan (“FDP”) for the Corvina field in Block Z-1, which is May 31, 2010.

 

On January 25, 2010,we applied for an extended well testing permit in Corvina for the first fivewells (the CX11-21XD, CX11-14D, CX11-20XD, CX11-18XD and the CX11-15D wells,collectively the “first five wells” or “five Corvina wells”) as we believeit is necessary to continue gathering data to fully understand the drivemechanisms that are present in Corvina.  On March 23, 2010, wereceived a decision from the DGH notifying us that they are approving us tocontinue extended well testing on our first five Corvina wells, until the FDCPdate of May 31, 2010, subject to specific limits on the amount of naturalgas flared from each of the first five Corvina wells. Based on the natural gasflaring limits set by the DGH, we have constrained the oil production fromthose five Corvina wells in order to comply with those limits.  The actual future decrease in production fromthese five Corvina wells will not be known until we fully implement our gasflaring mitigation strategy to optimize oil production while complying with thegas flaring limits, but we estimate the production from these wells hasdecreased by approximately 650 bopd compared to the production of these wellsduring the fourth quarter of 2009. Additionally we estimate that the productionfrom these wells could continue to be decreased by as much as 400 to 800 bopd.

 

We initially planned tohave the needed gas and water reinjection facilities at the CX-11 platform bythe approved FDCP of May 31, 2010. However, this no longer appears to be achievable due to the delayeddelivery of certain equipment. If we are unable to receiveand install the necessary gas and water reinjection equipment and receiveapproval of the corresponding environmental permits by May 31, 2010, wemay not be permitted to produce from some or all of the oil wells in Corvinauntil such installation is completed or an extension of the May 31, 2010date is obtained.  We have applied to the proper authoritiesfor an extension of the May 31, 2010 date to be able to maintain testingthe wells in Corvina; however, no assurance can be given that such extensionwill be awarded.  Depending on the extent of the delay, we plan to use theadditional time to drill one or two more wells from the CX-11 platform afterthe current well, the CX11-22D is completed. Further, we may not be able to produce any well drilled after December 13,2009 for a period longer than the initial six month testing period. Our currentview is that we may be able to produce our new wells CX11-17D, CX11-19D,CX11-22D, and any other well we may drill at the CX-11 platform for at leastsix months, as stated by the new well testing regulations.  Testing these wells beyond the initial sixmonth period will require a special application to the Ministry of Energy andMines, who may not grant approval.

 

Inaddition, we are in the initial stages of appraising, exploring and developingour potential oil and natural gas reserves in the Albacora field of BlockZ-1.  Our first well in Albacora hasbeen, and all new wells drilled in Albacora will be, placed in the initialsix-month production testing under the new legislation.  As in Corvina, we will need to receiveapproval for all the pertinent environmental and technical permits and installthe required gas and water reinjection facilities at the Albacora platform inorder to transition from exploration to commercial production, which ascurrently estimated could take up to two years. If we do not receive extended well testing permits on wells in Albacorabeyond the original six-month test period, we will experience an interruptionin production that would negatively impact any revenue and cash flow associatedwith those wells until the applicable requirements are satisfied for commercialproduction.

 

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**OilDevelopment**

 

***General***

 

We will conduct additional drilling activities basedin part on an ongoing assessment of economic efficiencies, likely success andlogistical issues such as license requirements, scheduling, requiredmaintenance and replacement of equipment.  This assessment could result inincreased emphasis and activities on a given prospect and conversely, couldresult in decreased emphasis on a given prospect for a period of time.  Inparticular, we will assess allocation of our current resources among theCorvina, Albacora, and Delfin fields and certain onshore prospects as theydevelop.

 

***Seismic DataAcquisition***

 

We are in the initial process of acquiring seismicdata to assist us in exploring, appraising and developing certain areas ofinterest within our blocks located in northwest Peru. The purpose of theseismic survey is to improve the subsurface imaging of certain areas within theblocks in order to better define the position of future wells as well as tocomply with our exploration commitments under our license contracts.

 

For Block Z-1, we intend to acquire approximately1,500 square kilometers of three dimensional (“3-D”) seismic data.  The 3-D seismicdata survey will include areas of interest within the Corvina, Albacora, andDelfin fields as well as certain prospects and leads located within the Meroand Piedra Redonda regions and certain deep water leads located within BlockZ-1. Additionally, the 3-D seismic survey will include data underneath fourexisting platforms in the Albacora, Corvina and Piedra Redonda fields. The seismic data survey will fulfill our commitments under the fourthexploration period of the Block Z-1 license contract if conducted within theallowed contractual time frame.  Weinitially attempted to conduct this seismic survey in late 2009, but suspendedthe survey as directed by the Ministry of Energy and Mines, due to issuesrelating to our corporate social responsibility program and insuring that allstakeholders in our area of influence understood and participated in theenvironmental permitting process.  We arecurrently working on a new seismic environmental permit and we estimate the 3-Dseismic data survey to be completed by 2011.

 

For Block XXIII, we intend to acquire approximately360 square kilometers of 3-D seismic data and 290 kilometers of two dimensional(“2-D”) seismic datawhich will include certain areas of interest within the Palo Santo region andfour other prospects that are part of the Mancora gas play.  We expect the3-D and 2-D seismic data survey to be completed by the first quarter of 2011.

 

For Block XXII, we intend to acquire approximately 260kilometers of 2-D seismic data on four potential prospects. We expect the 2-Dseismic data survey to be completed by the end of 2010.

 

***Corvina Field***

 

We are producing oil from the CX-11 platform, located in the Corvinafield within the offshore Block Z-1, under a well testing program that startedon November 1, 2007.  The Corvina field consists of approximately47,000 acres in water depths of less than 300 feet.  We are currentlyconcentrating our drilling efforts on West Corvina, which consists of 3,500acres and have completed a total of seven oil wells, the CX11-17D, theCX11-19D, the CX11-15D, the CX11-21XD, the CX11-20XD, the CX11-18XD and theCX11-14D.  The oil is delivered by tank vessel to the Petroperu refineryin Talara, located approximately 70 miles south of the platform.  Producedoil is kept in production inventory until such time it is delivered to therefinery.

 

In February 2010, we completed the CX11-17D wellin the Corvina field in offshore Block Z-1 in northwest Peru. The CX11-17D wellis the seventh oil well from the CX-11 platform and has been placed into theproduction well testing program. The CX11-17D well was drilled and successfullycompleted into a proved undeveloped area of the Corvina field, targeting sandscurrently being produced in other wells. The initial performance of the well will be evaluated over a period oftime to assess a stabilized production rate.

 

As with the CX11-19D well which was completed in December 2009and placed into the production well testing program, the CX11-17D well wascarefully evaluated prior to placing it into the ongoing production testingprogram. Although each of the previous Corvina wells have declined differently,partly due to the fact that these wells were completed in different zones andsome of the wells encountered mechanical problems, they all have initiallyshown typical solution gas drive behavior which can lead to significantdeclines during the first year of production before leveling off to sustainablerates. However, the representative rates of decline remain to be determined, asthe effective production mechanism in the Corvina field has yet to be fullyunderstood. Hence the need to continue testing these initial wells.

 

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The CX11-17D well is currently being tested andproduced under the new well testing regulation giving companies six months toevaluate a well before applying for the extended well testing program. We planto have the needed gas and water reinjection facilities at the CX-11 platformas soon as possible. The initial estimated date of May 31, 2010, proposedby us and viewed as reasonable by Perupetro, no longer appears to be achievabledue to the delayed delivery of certain equipment. We are currently targeting arevised date to have all equipment in place during the fourth quarter, as wellas all other requirements complied with, at which time the CX11-17D as well as theCX11-19D would be placed into commercial production. Any delays in deliveringor commissioning reinjection equipment or delays in other permitting aspectsmay force us to shut-in both the CX11-17D well, the CX11-19D well, and ourother Corvina wells, until we are ready to transition from exploration toexploitation, unless we obtain an approval for extended well testing for eachwell as required by the regulations.

 

We are currently drilling the CX11-22D well.  The CX11-22D well will be dual completed, andwe expect this will extend the drilling time compared to the CX11-17D.  The long string of the dual completion willtarget one set of oil sands, leaving the other two sets for later use.  The short string will be set at the Tumbesformation for water reinjection, as part of our project to transition tocommercial production.  We expect to havethe well on production mid-second quarter.

 

The Corvina wells have seen initial declines ofapproximately 50% during the first year of production before stabilizing. We donot believe these results are indicative of the Corvina field generally, butare instead the result of technical/mechanical problems encountered with ourinitial wells; however, it is possible we will see similar production declineswith new Corvina wells. Further, our ability to produce indicated reserves inCorvina depends on our ability to finance our continued operations, install thenecessary gas and water reinjection equipment and get our produced oil tomarket. While we do not foresee difficulties in meeting these requirements, anyfailure to do so could negatively affect our indicated reserves as reportedunder SEC rules. As such, in the evaluation of reserves, we attempt to account for all possible delays we are aware ofand their impact on the production forecast and remaining reserves to beproduced.

 

***Albacora Field***

 

The Albacora field islocated in the northern part of our offshore Block Z-1 in northwest Peru. The current area of interest within the Albacora field is a mapped structure ofapproximately 7,500 acres and is located in water depths of less than 200 feet.In December 2009, we completed our first oil well in the Albacora field,the A-14D well, under a production testing program pursuant to the newregulations.

 

In January 2010, we commenced drilling the A-15D,the second Albacora well, which was to be drilled to approximately 13,000 feetvertical depth and intended to test prospective sands below the lowest knownoil sands tested or produced to date in the field. In mid-January 2010, westopped oil production and drilling activities in order to install thepermanent production equipment on the A platform.  In February 2010, we resumed drilling ofthe A-15D well as well as resumed testing the A-14D.

 

In March 2010, while drilling the A-15D andpreparing to run our 9 5/8” casing to the top of the Zorritos formation, wefound that the 13 3/8” casing of the previous section had been damaged, forcingus to abandon the well. The failure of the 13 3/8” casing was apparently causedby the tilting of the drilling rig, which in turn was evidently caused when oneof the main beams supporting the top deck of the platform bent due to theconcentration of stresses at the base of the drilling rig.  The platform was successfully repaired andsubsequently, we began drilling the A-16D well, a follow up to the A-15D well,in April 2010.

 

The A-16D well wasoriginally intended to follow the same trajectory of the A-15D with the sametwo targets and the same objectives.  Howeverin May 2010, due to the lack of drilling progress as a result of obstructionspresent under the seabed, we have decided to temporarily abandon the A-16D,until we have a better understanding of what the obstructions are under theseabed and can evaluate the possibility of coming back to that slot with theproper equipment. Accordingly, we are now moving to another slot on theplatform and will begin drilling the next Albacora well, once the rig is movedand a thorough inspection and cleaning of the seabed is completed.

 

Currently, we are still in the process of negotiatingan initial short-term oil sales contract with the Talara refinery and otherinterested parties.  We initiallyexpected a contract to be finalized prior to the end of the first quarter2010.  However, due to the high

 

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salt content in the oil and the need for additionalequipment and chemicals required to reduce the salt to acceptable levels,negotiations have been extended.

 

Consistent with ourmethodology for Corvina, we have requested our independent petroleum engineers,Netherland, Sewell & Associates, Inc (“NSAI”), to evaluate thereserves of the Albacora oil field using what we believe are reasonablyconservative estimates of known uncertainties, such as the scheduling fordrilling and installation of necessary production equipment and the timingduration to apply for and receive the necessary regulatory permits. Consequently, we conservativelysimulated the shut-in of certain production over a period of time reasonablyexpected to occur while the issues are being resolved.

 

**Financing Activities**

 

***September 2009Private Placement of Common Stock***

 

On September 15, 2009, we closed a privateplacement of approximately 1.6 million shares of common stock, no par value, tothe International Finance Corporation (“IFC”) pursuant to a SubscriptionAgreement dated September 15, 2009. This private placement was related toour registered direct offering of approximately 18.8 million shares of CommonStock at a price of $4.66 per share that closed on June 30, 2009. Pursuantto the Subscription Agreement dated December 16, 2006 (the “SubscriptionAgreement”) by and between IFC and us, IFC has the right, within 45 days ofnotice of the offering, to purchase shares of our Common Stock for the sameprice and terms as the participants in an offering to retain its proportionateownership in us. IFC exercised its pre-emptive right to purchase approximately1.6 million shares of Common Stock at the offering price of $4.66 per share towhich it was entitled under the Subscription Agreement, resulting in grossproceeds to us of approximately $7.6 million. The transaction was submitted toand approved by the shareholders of BPZ at a Special Meeting of Shareholders onAugust 24, 2009. No warrants or dilutive securities were issued to IFC inconnection with the private placement. The shares were placed directly by us.We used the proceeds of this offering to develop our properties under ourexisting license contracts and other general corporate purposes consistent withour operating plans.

 

Under the September 15, 2009 SubscriptionAgreement, we committed to file a registration statement with the SEC coveringthe shares no later than 45 days after the closing with respect to such shares,and will use our reasonable best efforts to obtain its effectiveness no laterthan the earlier of (i) 90 days after the closing with respect to suchshares, or in the event of SEC review of the registration statement, 120 daysafter the closing and (ii) the third business day following the date onwhich BPZ is notified (orally or in writing, whichever is earlier) by the SECthat the registration statement will not be reviewed or is no longer subject tofurther review and comment unless, upon the advice of legal counsel, it isadvisable not to accelerate the effectiveness of such registration statement.On October 21, 2009, we filed a registration statement with the SECcovering the shares. Subsequently, we received comments from the SEC pertainingto our registration statement, Form 10-K for the year ended December 31,2008, Definitive Proxy Statement filed on April 30, 2009, Form 10-Qfor the period ended September 30, 2009 and the related earnings pressrelease as described below under “SEC Comments”. We promptly responded to theSEC’s requests. In May 2010 we filed an amended registration statementwith the SEC and expect the amended registration statement will be declaredeffective later in May 2010. There are no penalty payments associated withthe delay in obtaining effectiveness of the registration statement.

 

**Gas-to-Power Project**

 

TheCorvina gas-to-power project entails the installation of a 10-mile gas pipelinefrom the CX-11 platform to shore, the construction of gas processing facilitiesand the building of an approximately 135 megawatt (“MW”) simple-cycle electricgenerating plant.  The proposed power plant site is located adjacent to anexisting substation and power transmission lines which, after the Peruviangovernment completes their expansion, are expected to be capable of handling upto 320 MW of power. The existing substation and transmission lines are ownedand operated by third parties.

 

In order to support our proposed electric generationproject, we commissioned an independent power market analysis for the region.The Peruvian electricity market is deregulated and power is transported throughan interconnected national grid managed by the Committee for EconomicDispatching of Electricity (known as “COES”). Based on this study, we believewe will be able to sell economic quantities of electricity from the initial 135MW power plant. The market study also indicates that there may be futureopportunities for us to generate and sell significantly greater volumes ofpower into the Peruvian and possibly Ecuadorian power markets. Accordingly, the revenues from the natural gas delivered to the power plantwill be derived from the sale of electricity.

 

We currently estimate thegas-to-power project will cost approximately $150.0 million, excluding 19%value-added tax which will be recovered via early recovery and/or futurerevenue billings.  The $150.0 million includes $130.0 million for the

 

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estimated cost of thepower plant and $20.0 million for the estimated cost of the construction of thenatural gas pipeline. While we have identified and held discussion with severalpotential joint venture partners for the gas-to-power project in an attemptto secure additional equity for the project, we have not entered into anydefinitive agreements with a potential partner. In the eventwe are able to reach an agreement with a potential joint venture partner, wemay only retain a minority position in the project. However, we expect toretain the responsibility for the construction of the pipeline as well asretain ownership of the pipeline. If we are unable to reach an agreement with apotential partner, we plan to continue moving the project forward to completionwithout a partner. We are currently in the process of identifying and securing the additionalfinancing necessary to move the project forward, if a suitable joint venturepartner is not identified.

 

**SEC Comments**

 

In connection with a registration statement filed on October 21,2009 to register shares issued to IFC in a private transaction, we receivedcomments from the SEC pertaining to our registration statement, our Form 10-Kfor the year ended December 31, 2008, our Definitive Proxy Statement filedon April 30, 2009, and our Form 10-Q for the period ended September 30,2009 and the related earnings press release. In general, the questions orcomments from the SEC related to: (i) clarifications in several of ourdisclosures; (ii) the basis for the assumptions underlying our SEC oilreserves reported for 2008 in light of our actual production performance in2009; (iii) the reasons our 2009 production fell short of 2008projections; (iv) the consideration we gave to the reasonable certainty ofour assumptions underlying our SEC oil reserves and the related accountingreported in our financial statements; and (v) how we are taking intoconsideration certain items and uncertainties for our 2009 reserves report. Wepromptly responded to the SEC’s requests and, where appropriate, madeclarifications to our disclosures. On April 14, 2010, the SEC notified usthat they had no further comments at that time.

 

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**Results ofOperations**

 

The following table sets forth revenues and operatingexpenses for the three months ended March 31, 2010 and 2009 (inthousands):

 
| ** **                                        | ** ** | **Three Months Ended**              | ** ** | ** **    | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------|------------|---------------|------------|
| ** **                                        | ** ** | **March31,**                                  | ** ** | **Increase/** | ** ** |
| ** **                                        | ** ** | **2010**                                      | ** ** | **2009**      | ** ** | **(Decrease)** | ** ** |
| ** **                                        | ** ** | **(in thousands except per bbl information)** | ** ** | ** **    | ** ** |
| Net  sales volume:                                |       |                                          |       |          |       |   |   |
| Oil  and condensate (MBbls)                       |       | 343                                           |       | 331           |       | 12 |   |
|                                              | ** ** | ** **                                    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Net  revenue:                                     |       |                                          |       |          |       |   |   |
| Oil  and condensate                               |       | $                                             | 24,045     |          | $          | 13,225 |   | $ | 10,820 |   |
|                                              | ** ** | ** **                                    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Average  sales price (approximately):             | ** ** | ** **                                    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Oil  (per Bbl)                                    |       | $                                             | 70.04      |          | $          | 39.97 |   | $ | 30.07 |   |
|                                              | ** ** | ** **                                    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Operating  expenses                               | ** ** | ** **                                    | ** ** | ** **    | ** ** | ** ** | ** ** |
| Lease  operating expense                          |       | 4,764                                         |       | 3,978         |       | 786 |   |
| General  and administrative expense               |       | 8,026                                         |       | 8,483         |       | (457 | ) |
| Geological,  geophysical and engineering expense  |       | 501                                           |       | 347           |       | 154 |   |
| Depreciation,  depletion and amortization expense |       | 9,489                                         |       | 7,878         |       | 1,611 |   |
| Total  operating expenses                         |       | $                                             | 22,780     |          | $          | 20,686 |   | $ | 2,094 |   |
|                                              |       |                                          |       |          |       |   |   |
| Operating  income (loss)                          |       | $                                             | 1,265      |          | $          | (7,461 | ) | $ | 8,726 |   |

 

*Net Revenue*

 

For both the three months ended March 31, 2010and 2009, all oil sales were from oil produced from the CX-11 platform, locatedin the Corvina field within Block Z-1 in northwest Peru, under a well testingprogram.

 

For the three months ended March 31, 2010, ournet revenue increased by $10.8 million to $24.0 million from $13.2 million forthe same period in 2009. The increase in net revenue is due to an increase of$30.07, or 75%, in the average per barrel sales price received and a slightincrease in the amount of oil sold, 12 MBbls. During the first quarter of 2010,oil prices have remained consistent at $70 - $80 per barrel compared to lowprices during the first quarter of 2009 which ranged from $39 -$51 per barrel.

 

For the three monthsended March 31, 2010, we had six producing wells in the Corvina field, theCX11-17D, CX11-19D, CX11-20XD, CX11-18XD, CX11-21XD and the CX11-15D, comparedto four producing wells, the CX11-20XD, CX11-18XD, CX11-21XD and the CX11-14D,during the same period in 2009. Although the number of wells contributing tosales increased in 2010, we constrained the oil production from some or all ofour first five Corvina wells (the CX11-21XD, CX11-14D, CX11-20XD, CX11-18XD andthe CX11-15D wells) in order to comply with the natural gas flaring limits setby the DGH. In addition, oil production from the CX11-14D well has beensuspended since November 7, 2009 due to water issues in production thatcaused sand production and lifting issues. Therefore, the majority of oilproduced and sold in the first three months ended March 31, 2010 came fromthe latest wells, the CX11-17D and CX11-19D, which were not subject to the gasflaring limits during such time. During the three months ended March 31,2009, our then producing wells were not subject to the natural gas flaringlimits set by the DGH, whose legislation regulating well testing in Peru becameeffective by means of a Supreme Decree in December 2009.

 

The revenues above arereported net of royalties owed to the government of Peru. Royalties areassessed by Perupetro as stipulated in the Block Z-1 license agreement based onproduction levels. However, the royalty calculation is based on the priorfive-day average of a blend of crude oil prices before the crude oil deliverydate, as opposed to the price we receive for oil which is based on the priortwo-week average of a blend of crude oil prices before the crude oil deliverydate. For the three months ended March 31, 2010 and 2009, the revenues received by us are net ofroyalty costs of approximately 5% and 6% of gross revenues or $1.3 million and$0.8 million, respectively.

 

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*Lease Operating*

 

Lease operating expenses include costs incurred tooperate and maintain wells and related equipment and facilities. These costsinclude, among others, workover expenses, operator fees, processing fees,insurance and transportation.  For thethree months ended March 31, 2010, lease operating expenses increased by$0.8 million to $4.8 million ($13.88 per Bbl) from $4.0 million ($12.02 perBbl) for the same period in 2009. The increase in the lease operating expensesis comprised of increased maintenance and repairs for marine vessels of $0.3million, $0.2 million of increased contract pumping and processing fees, $0.1million of increased insurance costs, and $0.2 million of increased oiltransportation costs compared to the same period in 2009. The reason for theincreased costs and per barrel lease operating expenses is due to the increasein the number of wells and fields in 2010 compared to that of 2009.

 

Although oil transportation costs increased by only$0.2 million, we began chartering a double-hull tanker with a capacity ofapproximately 65,000 barrels and the leasing of a storage vessel with capacityof approximately 160,000 barrels in February 2010 in order to upgrade ouroil transportation capabilities. As we are still negotiating an oil salescontract for the oil produced from the A platform in the Albacora field, thelease operating expenses associated with oil production are capitalized as partof the cost of oil inventory. As of March 31, 2010, we had approximately$2.2 million of production expenses associated with 90.5 MBbls of oil producedfrom the Albacora field included in oil inventory, or $24.3 per barrel. Oncethis inventory is sold, the production expenses will be included in leaseoperating expenses.  We therefore expectthe per barrel amount of lease operating expense to increase until oilproduction and sales increase to a sufficient level to reduce per barrelexpense of the monthly chartering and leasing costs associated with theseadditional vessels.

 

*General and Administrative*

 

General and administrative expenses areoverhead-related expenses, including employee compensation, legal, consultingand accounting fees, insurance, and investor relations expenses. For the threemonths ended March 31, 2010, general and administrative expenses decreased$0.5 million to $8.0 million from $8.5 million for the same period in2009.  Stock-based compensation expense, a subset of general andadministrative expenses, decreased by $1.4 million to $1.9 million for thethree months ended March 31, 2010 from $3.3 million for the same period in2009. The decrease in stock-based compensation expense is due to the vesting ofthe majority of awards granted in 2007 and 2008, which were granted at a timewhen the grant date fair value was higher due to the high price of our commonstock. As the majority of these awards have vested by the end of January 2010,the expense for the three months ended March 31, 2010 is less than theexpense for the same period in 2009. Other general and administrative expensesincreased $0.9 million to $6.1 million from $5.2 million for the same period in2009. The $0.9 million increase is due to $0.6 million of increased profitsharing expense and $0.2 million of increased salary and salary relatedexpenses. During the three months ended March 31, 2009, certain executiveand other key personnel agreed to a voluntary salary reduction of 5% to 15% oftheir base salaries and the Chairman of the Board of Directors agreed to forgohis salary for 2009. During the three months ended March 31, 2010, themajority of executives and other key personnel, including the Chairman of theBoard of Directors, who experienced a voluntary salary reduction for the firstthree months of 2009, had their salary reinstated, by the Board of Directors,for the full three months of 2010. Contributing to the change in other generaland administrative expenses are $0.2 million of increased travel and travelrelated expenses and $0.5 million of accounting and consulting expense that ispartially offset by $0.4 million of decreased legal expenses and $0.2 millionof decreased equipment rental and other general corporate expenses.

 

*Geological, Geophysical andEngineering*

 

Geological, geophysical and engineering expensesinclude laboratory, environmental and seismic acquisition related expenses. Forthe three months ended March 31, 2010, geological, geophysical andengineering expenses increased $0.2 million to $0.5 million compared to $0.3million for the same period in 2009. The increase of $0.2 million is due toincreased laboratory and consulting costs as a result of more environmentalimpact studies performed on Blocks XIX, XXII and XXIII in the current yearcompared to the activities of the prior year.

 

*Depreciation, Depletion andAmortization*

 

For the three months ended March 31, 2010,depreciation, depletion and amortization expense increased $1.6 million to $9.5million from $7.9 million for the same period in 2009. For both the threemonths ended March 31, 2010 and 2009, depletion expense comes from oilsold from the Corvina field. The increase in depreciation, depletion andamortization expense is due to increased depletion expense as a result of areduction in the reserve base in 2009 as a result of the 2009reserve analysis as prepared by NSAI. The reserve analysis included a 1.6MMBbls negative revision in reserves due to the lower than expected performanceof the CX11-14D, CX11-18XD, and CX11-20XD wells.

 

For the three monthsended March 31, 2010 and 2009, depreciation, depletion and amortizationexpense excludes $0.4 million and $0.3 million, respectively, of depreciationexpense that was capitalized to construction in progress.

 

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*Other Income (Expense)*

 

For the three months ended March 31, 2010, incomefrom our investment in Ecuador property, net of investment amortization,remained flat at an expense of approximately $47,000. The reason for theexpense being the same for both periods is due to not receiving any paymentswhile recognizing the same amortization expense for both periods.

 

For the three monthsended March 31, 2010, we recognized approximately $1.9 million of netinterest expense which includes $3.3 million of interest expense reduced by$1.4 million of capitalized interest expense. For the same period in 2009, wedid not recognize any interest expense as we capitalized all interest expenseof $0.9 million to construction in progress.

 

For the three months ended March 31, 2010, otherexpense decreased by $0.8 million to income of approximately $6,000 in 2010from an expense of $0.8 million in 2009.  The reason for the decrease inexpense is due to approximately $0.8 million of expense incurred in 2009 thatwas not repeated in 2010 related to the settlement of a disputed contractualobligation with a former consultant of ours concerning services provided toboth BPZ and its predecessor at the time BPZ became publicly traded.

 

*Income Taxes*

 

For the three monthsended March 31, 2010, we recognized an income tax expense of approximately$1.1 million on a net loss before income tax of approximately $0.7 million. Forthe same period in 2009, we recognized an income tax benefit of approximately$1.2 million on a net loss before income tax of approximately $8.3 million. Thedifference between the effective tax rate recognized and the 22% statutory rateprovided for under the Block Z-1 License Contract is largely due to:

 

·      We have a 100% allowance on our net operating lossesgenerated in the United States - We have a valuation allowance for the fullamount of the domestic deferred tax asset resulting from the income tax benefitgenerated from net losses in the U.S., as we believe, based on the weight ofavailable evidence, that it is more likely than not that the deferred tax assetwill not be realized prior to the expiration of net operating losscarryforwards in various amounts through 2027.

 

·      Certain U.S. expenses are not deductible in Peru - Thetax benefit is based on a taxable Peruvian loss that excludes certain U.S.expenses that are not deductible at the Peruvian level.

 

Estimated interest andpenalties related to potential underpayment on unrecognized tax benefits, ifany, are classified as a component of tax expense in the Consolidated Statementof Operations. For both the three months ended March 31, 2010 and 2009, wedid not have any accrued interest or penalties associated with any unrecognizedtax benefits, nor was any interest expense recognized during those periods.

 

For the three months ended March 31, 2010, ournet loss decreased $5.3 million to a net loss of $1.8 million or ($0.02) perbasic and diluted share from net loss of $7.0 million or ($0.08) per basic anddiluted share for the same period in 2009.

 

**Liquidity,Capital Resources and Capital Expenditures**

 

AtMarch 31, 2010, we had cash and cash equivalents of $131.2 million andcurrent accounts receivable related to our March oil sales of $10.9million, all of which was collected in early April 2010.   We also had $28.1 million in Value Added Taxreceivable, which we will collect over time as we invoice our oil sales.

 

At March 31, 2010, we had trade accountspayable and accrued liabilities of $42.7 million.

 

At March 31,2010, our outstanding long-term debt and short-term debt consisted of a $15.0million IFC Facility bearing interest at LIBOR plus 2.75% due December 31,2012, and 2015 Convertible Notes whose net amount of $136.8 million includesthe $170.9 million of principal reduced by $34.1 million of the remainingunamortized discount. At March 31, 2010, the current and long-termportions of our capital lease obligations, primarily related to the barges usedin our marine operations were $4.4 million and $6.6 million, respectively.

 

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| ** **                   | ** ** | **For the Three Months Ended** | ** ** |
|------------------------------|------------|--------------------------------|------------|
| ** **                   | ** ** | **March 31,**             | ** ** |
| **Cash Flows**               | ** ** | **2010**                       | ** ** | **2009** | ** ** |
| ** **                   | ** ** | **(in thousands)**        | ** ** |
| Cash  provided by (used in): |       |                           |       |   |   |
| Operating  activities        |       | $                              | (9,889     | ) | $ | 1,439 |   |
| Investing  activities        |       | (40,027                        | )          | (16,930 | ) |
| Financing  activities        |       | 162,926                        |       | 38,656 |   |
|                              |            |                                |            |  |  |  |  |

 

*Operating Activities*

 

Cash provided by (usedin) operating activities decreased by $11.3 million to a use of cash of $9.9million for the three months ended March 31, 2010 from a source of cash of$1.4 million for the same period in 2009. Cash flow before changes in operatingassets and liabilities increased by $6.3 million reflecting a lower netloss of $5.3 million due to higher oil production revenues and $1.0 millionhigher non-cash charges during 2010 compared to 2009. Changes in operatingassets and liabilities provided a use of cash of $17.6 million.  In 2010, the change in accounts receivableprovided a use of cash of $8.0 million and in 2009 provided a source of cash of$1.5 million, the change being a net use of cash of $9.5 million. The reasonfor the change is due to the higher accounts receivable balances in 2010 as aresult of higher oil prices experienced and the timing of when the accountsreceivables are collected. In 2010 the change in other assets provided a use ofcash of $5.4 million and is due to the increase in other assets advancepayments made by us to secure casing and accessories for use in our current andfuture operations.  The net change in valueadded tax receivable, inventory, and liabilities provided a use of cash ofapproximately $2.7 million and is a result of higher revenues and better cashmanagement. The increase in the value-added tax receivable was lower for thethree months ended March 31, 2010 compared to the same period in 2009because we were more profitable during 2010 and we paid off more liabilities inorder to better manage our obligations.

 

*Investing Activities*

 

Net cash used in investingactivities increased by $23.1 million to cash used in investing activitiesof $40.0 million for three months ended March 31, 2010 from $16.9 millionin 2009 and is due to increased capital expenditures of $22.4 million in 2010as we are operating in two fields in 2010, the Corvina and Albacora fields,while we were operating in only one field during the same period in 2009, theCorvina field. Also contributing to the change in investing activities arechanges in restricted cash providing a use of cash of $0.7 million.

 

*2010Equipment Activity*

 

During the threemonths ended March 31, 2010, we incurred capital expenditures of approximately$40.7 million associated with our development initiatives for theexploration and production of oil and natural gas reserves and thecomplementary development of proprietary gas-fired power generation facility inPeru.

 

Of the incurred costs mentioned above, we incurredcapital expenditures related to the drilling and testing of the CX11-19D,CX11-17D and CX11-22D in the Corvina field of approximately, $0.1 million, $7.5million and $7.4 million, respectively. In the Albacora field, we incurredcapital expenditures related to the drilling of the A-15D and A-16D ofapproximately $8.6 million and $1.8 million, respectively.

 

In 2009, we entered into a lease-purchase agreement toacquire the Don Fernando barge to serve as our construction lay barge as wellas tender assist barge for drilling and construction operations and the bargewill eventually be fitted to lay subsea pipe for the gas-to-power project.  During the three months ended March 31,2010, we capitalized an additional $4.6 million in order to have the bargeready to support our operations.

 

For the further development of the planned gas-firedpower generation facility, we incurred costs of approximately $3.0 million aspart of its agreement to purchase three LM6000 gas-fired turbines.

 

For the three months ended March 31, 2010, weincurred approximately $0.3 million for upgrades to our existing platforms aswell as incurred costs toward the construction of new platforms. In addition,we acquired $1.5 million in equipment for our production facilities at the Aplatform in Albacora as well as at the CX-11 platform in Corvina. We incurred$0.2 million for the purchase of machinery and equipment used in operations inPeru, $0.1 million for the Caleta La Cruz dock refurbishment, $3.6 million

 

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in assets in transit, $0.4 million in furniture andimprovements related to the new offices in Peru and $0.1 million related to theasset retirement obligation for the CX11-17D well.

 

For the three monthsended March 31, 2010, in accordance with the “successful efforts” methodof accounting, we capitalized approximately $0.4 million of depreciationexpense, mainly related to the tender assist barges serving as supportequipment, and $1.4 million of interest expense to construction in progress.

 

*FinancingActivities*

 

Cashprovided by financing activities increased by $124.3 million to $162.9million for the threemonths ended March 31, 2010 comparedto $38.7 million for the same period in 2009. The increase in cash provided byfinancing activities is due to increased borrowings of $169.9 million and lessrepayments of borrowings of $0.9 million that is partially offset by anincrease in cash paid for debt issue costs of $6.0 million and less cash raisedthrough equity issuances in 2009 of $40.5 million.

 

*Shelf Registration*

 

To finance our operationswe may sell additional shares of our common stock. Our certificate of formationdoes not provide for pre-emptive rights, although we may grant similar rightsby contract from time to time. We currently have approximately $134.6 millionin common stock available under an effective shelf registration statement,which we may sell from time to time in one or more offerings pursuant tounderwritten public offerings, negotiated transactions, block trades or acombination of these methods. This registration statement will expire on December 7,2010.

 

*Long-TermDebt and Capital Lease Obligations*

 

***At March 31, 2010 and December 31, 2009 long-termdebt and capital lease obligations consist of the following:***

 
| ** **                                                                            | ** ** | **March31,********2010** | ** ** | **December 31,********2009** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|
| ** **                                                                            | ** ** | **(in thousands)**       | ** ** |
|                                                                                  |       |                     |       |                              |       |
| $15 million IFC Senior  Note, Libor plus 2.75%, due 2012                              |       | $                        | 15,000     |                              | $          | 15,000 |   |
| $170.9  million Convertible Notes, 6.5%, due 2015, net of discount of ($34.1) million |       | 136,777                  |       | —                            |       |
| Capital  Lease Obligations                                                            |       | 10,966                   |       | 11,910                            |       |
| Other                                                                                 |       | —                   |       | 1,023                             |       |
|                                                                                  |       | 162,743                  |       | 27,933                            |       |
| Less:  Current Portion of Long-Term Debt and Capital Lease Obligations                |       | 6,912                    |       | 5,352                             |       |
|                                                                                  |       | $                        | 155,831    |                              | $          | 22,581 |   |

 

*$170.9 Million Convertible Notes due2015*

 

In February and March 2010, we closed on theprivate offering of an aggregate $170.9 million convertible notes due 2015 (the“2015 Convertible Notes”). The 2015 Convertible Notes offering was comprised of(i) the initial $140.0 million of 2015 Convertible Notes sold in aninitial private offering, (ii) the exercise, by the initial purchaser, ofa 30-day option to purchase an additional $21.0 million of 2015 ConvertibleNotes, and (iii) IFC’s election to participate in the offering, pursuantto a contractual right, for an additional $9.9 million of 2015 ConvertibleNotes, bringing the total proceeds of the private offering to $170.9 million.The convertible notes were sold to an initial purchaser who then sold the notesto qualified institutional buyers pursuant to Rule 144A of the SecuritiesAct of 1933. The $170.9 million of convertible notes were issued pursuant to anindenture dated February 8, 2010, between us and Wells Fargo Bank,National Association, as trustee (“the Indenture”).

 

The 2015 Convertible Notes are our general seniorunsecured obligations and rank equally in right of payment with all of ourother existing and future senior unsecured indebtedness.  The 2015Convertible Notes are effectively subordinate to all of our securedindebtedness to the extent of the value of the assets collateralizing suchindebtedness.  The 2015 Convertible Notes are not guaranteed by oursubsidiaries.

 

We will pay interest on the 2015 Convertible Notes ata rate of 6.50% per year on March 1st and September 1st of each year,beginning on September 1, 2010.  The 2015 Convertible Notes mature onMarch 1, 2015. The initial conversion rate is 148.3856 shares per $1,000principal amount of the 2015 Convertible Notes (equal to an initial conversionprice of approximately $6.74 per

 

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share of common stock), subject to adjustment. Uponconversion, we must deliver, at our option, either (1) a number of sharesof our common stock determined as set forth in the Indenture, (2) cash, or(3) a combination of cash and shares of our common stock (but not toexceed 19.99% of our outstanding shares at the time of such delivery).

 

The initial conversion rate may be adjusted on February 3,2011 if the volume weighted average price of our common stock for each of the30 trading days ending on February 3, 2011 is less than $5.6160 per share.In addition, following the occurrence of any one of certain corporatetransactions that constitutes a fundamental change (as defined in the Indenture),we will increase the conversion rate, subject to certain limitations, for aholder who elects to convert the 2015 Convertible Notes in connection with suchcorporate transactions during the 30-day period after the effective date ofsuch fundamental change.

 

Holders may convert their 2015 Convertible Notes attheir option at any time prior to the close of business on the second businessday immediately preceding the maturity date under the following circumstances:

 

(1) during any fiscal quarter (and only duringsuch fiscal quarter) commencing after March 31, 2010, if the last reportedsale price of our common stock is greater than or equal to 130% of theconversion price of the Notes for at least 20 trading days in the period of 30consecutive trading days ending on the last trading day of the preceding fiscalquarter;

 

(2) prior to January 1, 2015, during thefive business-day period after any ten consecutive trading-day period in whichthe trading price of $1,000 principal amount of the 2015 Convertible Notes foreach trading day in the measurement period was less than 97% of the product ofthe last reported sale price of our common stock and the conversion rate onsuch trading day;

 

(3) if the 2015 Convertible Notes have beencalled for redemption; or

 

(4) upon the occurrence of one of the specifiedcorporate transactions. Holders may also convert the 2015 Convertible Notes attheir option at any time beginning on February 1, 2015, and ending at theclose of business on the second business day immediately preceding the maturitydate.

 

On or after February 3, 2013, we may redeem forcash all or a portion of the 2015 Convertible Notes at a redemption price of100% of the principal amount of the notes to be redeemed plus any accrued andunpaid interest to, but not including, the redemption date, plus a “make-whole”payment if: (1) for at least 20 trading days in any consecutive 30 tradingdays ending within five trading days immediately before the date we mail theredemption notice, the “last reported sale price” of our common stock exceeded175% of the conversion price in effect on that trading day, and (2) thereis no continuing default with respect to the notes that has not been cured orwaived on or before the redemption date.

 

If we experience any one of the certain specifiedtypes of corporate transactions, holders may require us to purchase all or aportion of their 2015 Convertible Notes. Any repurchase of the notes pursuantto these provisions will be for cash at a price equal to 100% of the principalamount of the notes to be purchased plus any accrued and unpaid interest to,but excluding, the purchase date.

 

The Indenture contains customary terms and covenantsand events of default. If an event of default (as defined therein) occurs andis continuing, the Trustee by notice to us, or the holders of at least 25% inaggregate principal amount of the 2015 Convertible Notes then outstanding bynotice to us and the Trustee, may declare the principal and accrued and unpaidinterest (including additional interest or premium, if any) on the 2015Convertible Notes to be due and payable. In the case of an event of defaultarising out of certain bankruptcy events (as set forth in the Indenture), theprincipal and accrued and unpaid interest (including additional interest orpremium, if any), on the notes will automatically become due and payable.

 

Net proceeds from the sale of the 2015 ConvertibleNotes, after deducting the discounts and commissions and any offering expensespayable by us, was approximately $165.4 million.  The initial purchaserreceived commissions of approximately $5.5 million in connection with the saleof the Notes and we incurred approximately $0.5 million of direct expenses inconnection with the offering.  We intendto use the net proceeds for general corporate purposes, including withoutlimitation, capital expenditures and working capital, reduction or refinancingof debt, or other corporate obligations.

 

As a result of our adoption of the new accountingstandard for convertible debt that may be settled in cash upon conversion, weare required to separately account for the liability and equity components in amanner that reflects our non-convertible borrowing rate when interest cost isrecognized in subsequent periods. The value assigned to the liability componentis determined by measuring the fair value of a similar liability that does nothave an equity conversion feature. The value assigned to the equity componentis determined by deducting the fair value of the liability component from theinitial proceeds. The excess of the principal amount of the liability componentover its carrying amount (the non-cash discount) is amortized to interestexpense using the effective interest method over the term of the debtagreement. In addition, transaction costs incurred that directly relate to theissuance of convertible debt instruments must be allocated to the liability andequity components in proportion to the allocation of proceeds and accounted foras debt issuance costs and equity issuance costs, respectively. The accountingstandard requires retrospective restatement of all periods

 

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presentedback to the date of debt issuance with a cumulative effect of the change inaccounting principle on all prior periods being recognized as of the beginningof the first period.

 

We estimated ournon-convertible borrowing rate at the date of issuance of our 2015 ConvertibleNotes to be 12%.  The 12% non-convertibleborrowing rate represents the borrowing rate of similar companies with the samecredit quality as ours and was obtained through a quote from the initialpurchaser. Using the income method and discounting the principal and interestpayments of the 2015 Convertible Notes using the 12% non-convertible borrowingrate, we estimated the fair value of the $170.9 million 2015 Convertible Notesto be approximately $136.3 million with the discount being approximately $34.6million. The discount will be amortized as non-cash interest expense intoincome over the life of the notes using the interest method. In addition, werecorded approximately $4.8 million of the $6.0 million of fees and commissionsas debt issue costs that will be amortized over time using the interest methodas interest expense. The remaining $1.2 million of fees and commissions will betreated as an original issue discount against the value of the equitycomponent. We estimate the cash payments related to the 2015 Convertible Notes,assuming no conversion, for the years ended 2010, 2011, 2012, 2013, 2014 andthereafter to be approximately $6.4 million, $11.1 million, $11.1 million,$11.1 million, $11.1 million and $176.5 million, respectively.

 

As of March 31, 2010,the net amount of $136.8 million includes the $170.9 million of principalreduced by $34.1 million of the remaining unamortized discount. The net amountof the equity component is $33.4 million which includes the initial discount of$34.6 million reduced by $1.2 million of direct transaction costs. Theremaining unamortized discount of $34.1 million will be amortized into interestexpense, using the effective interest method, over the remaining life of theloan agreement, whose term expires in March 2015.  At March 31, 2010, using the currentconversion rate of 148.3856 shares per $1,000 principal amount of the 2015Convertible Notes, if the $170.9 million of principal were converted intoshares of common stock, the notes would convert into 25,364,737 shares ofcommon stock.  However, we arecurrently limited, by NYSE rules, to issuing up to 23,031,663 shares (19.99% ofthe stock outstanding at the time of the issuance of the 2015 ConvertibleNotes) in satisfaction of conversion of the 2015 Convertible Notes. Should weneed to issue shares in excess of the 19.99% limit, we would need approval bythe affirmative vote of the majority of shareholders in order to issue theshares in excess of the 19.99% limit. If $170.9 million of 2015 Convertible Notes were converted into commonstock as of March 31, 2010, using the market price of our common stock at March 31,2010 of $7.35, the if-converted value in excess of the principal amount wouldbe approximately $15.5 million.

 

For the threemonths ended March 31, 2010, the effective interest rate for the 2015Convertible Notes is 12%; including the amortization of debt issue costs, theeffective interest rate is 12.6%.  Theamount of interest expense related to 2015 Convertible Notes for the three monthsended March 31, 2010 is $2.2 million, disregarding capitalized interestconsiderations, and includes $1.7 million of interest expense related to thecontractual interest coupon, $0.4 million of non-cash interest expense relatedto the amortization of the discount and $0.1 million of interest expenserelated to the amortization of debt issue costs.

 

*$15.0Million IFC Reserve-Based Credit Facility*

 

We have a $15.0 millionreserve-based lending facility (“IFC Facility”) agreement (the “Loan Agreement”)with IFC through our subsidiaries BPZ E&P and BPZ Marine Peru S.R.L. asborrowers. The reserve-based lending facility matures in December 2012.

 

The reserve-based lendingfacility bears interest at an approximate rate of LIBOR plus 2.75%, currentlyequivalent to 3.19% based on the six month LIBOR rate of 0.44% at December 31,2009.  The maximum amount available under this facility begins at $15.0million and will be reduced by $2.5 million beginning on December 16, 2010and every six months thereafter during the term of the Loan Agreement. The amount available under the Loan Agreement is subject to a semi-annualborrowing base determination based on the value of oil reserves.  Inaddition, we are subject to various financial covenants calculated as of the lastday of each quarter, including a life of field coverage ratio, life of loancoverage ratio, debt to equity ratio and interest coverage ratio. In February 2010,we received a waiver from IFC for the life of field coverage ratio and life ofloan coverage ratio through August 2010. We also requested and received awaiver and amendment from IFC which extended the period of time to assign afirst priority lien on Empresa Electrica Nueva Esperanza S.R.L.’s interest inthe Agreement with GE for three gas-fired turbines to IFC until December 2010.Accordingly, we were in compliance with all material covenants of the LoanAgreement as of March 31, 2010.

 

The LoanAgreement provides for events of default customary for agreements of this type,including, among other things, payment breaches under any of the financedocuments for the first and second tranche of the senior debt; failure tocomply with obligations; representation and warranty breaches; expropriation ofthe assets, business or operations of any borrower; insolvencies of anyborrower; certain attachments against the assets of any borrower; failure tomaintain certain authorizations with respect to any

 

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financing documents with the IFC,the development and operation of the Corvina field in Block Z-1, any additionalpetroleum assets under license contracts with Perupetro or certain other keyagreements; revocation of any financing or security documents with the IFC orcertain key agreements; defaults on certain liabilities; certain judgmentsagainst the borrower or any subsidiary; abandonment or extended businessinterruption of the Corvina field or certain other petroleum assets; engagementin certain sanctionable practices; or restrictions are enacted in Peru thatcould inhibit any payment a borrower is required to make under the financingdocuments with the IFC.

 

If anevent of default occurs, IFC and any additional facility agent may (i) terminateall or part of the relevant facility; (ii) declare all or part of theprincipal amount of the loan, together with accrued interest, immediately dueand payable;  (iii) declare all or part of the principal amount ofthe loan, together with accrued interest, payable on demand; or (iv) declareany and all of the security documents under the facility enforceable andexercise its rights under such documents. In addition, if any borrower isliquidated or declared bankrupt, all loans and interest accrued on it or anyother amounts due, will become immediately due and payable without notice.

 

*Other*

 

In July 2009, we,through our subsidiary, BPZ E&P, entered into a $5.1 million short-termloan agreement to finance the purchase of casing and accessories for use in ourcurrent and future operations. The $5.1 million short-term loan bore an annualinterest rate of 5.45% and was to be repaid in five monthly installments ofapproximately $1.0 million starting September 2009.  In connectionwith the $5.1 million short-term loan agreement, we were required to deposit$1.0 million with the lending institution as a guaranty for the loan.  The$1.0 million was to be applied to the last installment of the loan repayments.In January 2010, the remaining principal amount of approximately $1.0million and, along with the accrued interest due, was repaid with the $1.0million deposit and cash.

 

*CapitalLeases*

 

We are party to several capital lease agreements, asmore fully described in our Form 10-K, as amended, for the year ended December 31,2009.  Generally, we enter into capitallease agreements in order to secure marine vessels in order to support ouroperations in Peru and to obtain furniture and fixtures for our offices locatedin Houston and Peru. The contractual term of the capital lease agreements rangebetween two to five years and the effective interest rate of the capital leaseagreements range between 5.94% and 34.9%.

 

For the three monthsended March 31, 2010, we recognized approximately $1.9 million of netinterest expense which includes $3.3 million of interest expense reduced by$1.4 million of capitalized interest expense. For the same period in 2009, wedid not recognize any interest expense as we capitalized all interest expenseof $0.9 million to construction in progress.

 

*PerformanceBonds*

 

As of March 31,2010, we have restricted cash deposits of $5.5 million. In connection with ourproperties in Peru, we have obtained four performance bonds totaling $5.3million that are partially collateralized by restricted cash deposits of $3.1million to insure certain performance obligations and commitments under thelicense contracts for Blocks Z-1, XIX, XXII and XXIII. Additionally, we have$2.4 million of restricted cash to collateralize insurance bonds for importduties related to the BPZ-01 barge and crane on board the BPZ-01 and anunsecured performance bond of $0.1 million to guarantee our performance underour new office lease agreement in Peru.

 

All of the performanceand insurance bonds are issued by Peruvian banks and their terms are governedby the corresponding license contracts, customs laws, lending practices orrental practices.

 

**Liquidity Outlook**

 

Weestimate for 2010 our required principal and interest payments for our outstandingdebt to be approximately $10.1 million, our required principal andinterest payments for our capital lease obligations to be approximately$7.2 million and capital expenditures to be approximately $182.2 million(which includes $104.7 million for the drilling, development and production inthe Corvina field and Albacora field, both fields are located in Block Z-1 innorthwest Peru, $29.8 million  for thedrilling and development of Blocks XIX and XXIII, $12.5 million for additionalmarine support operations and $35.2 million for the three LM6000 gas-firedturbines). In addition, we expect to incur approximately $18 million in seismicacquisition costs for Blocks XXII and XXIII.

 

Our major sources of funding to date have beenthrough oil sales, equity raises, convertible debt issuances and, to a lesser

 

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extent,debt financing activities.  With ourcurrent cash balance, current and prospective Corvina and Albacora oildevelopment cash flow, our recent convertible debt issuance, other potentialthird-party financing and potential financing from future equity raises, webelieve we will have sufficient capital resources to execute our currentCorvina and Albacora oil development projects as well as service our currentdebt obligations and plan to continue pursuing our gas-to-power project onceproject funding becomes available. However, the timing and execution of our projectis dependent on a variety of factors, including the technical design offacilities, permitting approval, availability of equipment, time and costsrequired for delivery of materials and construction operations, performance bycontractors and the success of planned financing, many of which factors areoutside our control and cannot be assured.

 

**Off-BalanceSheet Arrangements**

 

As of March 31,2010, we had 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 Estimates**

 

In our annual report on Form 10-K for the year ended December 31,2009, as amended, we identified our most critical accounting policies. Inpreparing the financial statements, we make assumptions, estimates andjudgments that affect the amounts reported. We periodically evaluate ourestimates and judgments that are the most critical in nature which are relatedto oil reserves, successful efforts method of accounting, revenue recognition,impairment of long-lived assets, future dismantlement, restoration, andabandonment costs, as well as stock-based compensation. Our estimates are basedon historical experience and on our future expectations that we believe arereasonable. Those estimates and assumptions affect the reported amounts ofassets, liabilities, revenues and expenses in the consolidated financialstatements, and the disclosure of contingent assets andliabilities. Actual results are likely to differ from our currentestimates and those differences may be material.

 

In February 2010, the Financial AccountingStandards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-09,“Subsequent Events,” which amends ASC Topic 855 to eliminate the requirement todisclose the date through which management has evaluated subsequent events inthe financial statements. ASU No. 2010-09 was effective upon issuance andits adoption had no impact on our financial position, results of operations orcash flows.

 

In January 2010, we partially adopted theprovisions of FASB ASU No. 2010-06, “Improving Disclosures about FairValue Measurements,” which amends ASC Topic 820 to require new disclosuresconcerning (1) transfers into and out of Levels 1 and 2 of the fair valuemeasurement hierarchy, and (2) activity in Level 3 measurements. Inaddition, ASU No. 2010-06 clarifies certain existing disclosurerequirements regarding the level of disaggregation and inputs and valuationtechniques and makes conforming amendments to the guidance on employers’disclosures about postretirement benefit plans assets. The requirements todisclose separately purchases, sales, issuances, and settlements in the Level 3reconciliation are effective for fiscal years beginning after December 15,2010 (and for interim periods within such years). As such, we will apply thedisclosure requirements relative to the Level 3 reconciliation in the first quarterof 2011. There was no impact on our financial position, results of operationsor cash flows as a result of the partial adoption of ASU No. 2010-06. Forfurther information, please see Note 11, “Fair Value Measurements andDisclosures”.

 

**Disclosure Regarding Forward-LookingStatements**

 

We caution that thisdocument contains forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995, Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934.  All statements, other than statements ofhistorical facts, included in or incorporated by reference into this Form 10-Qwhich address activities, events or developments which we expect, believe oranticipate will or may occur in the future are forward-looking statements.  The words “believes,” “intends,” “expects,” “anticipates,”“projects,” “estimates,” “predicts,” “plans” and similar expressions, or thenegative thereof, are also intended to identify forward-lookingstatements.  In particular, statements,expressed or implied, concerning future operating results, the ability toreplace or increase reserves, or to increase production, or the ability togenerate income or cash flows are by nature, forward-looking statements.  These statements are based on certainassumptions and analyses made by the management of BPZ in light of itsexperience and its perception of historical trends, current conditions andexpected future developments as well as other factors it believes areappropriate in the circumstances. However, forward-looking statements are not guarantees of performanceand no assurance can be given that these expectations will be achieved.

 

Important factors thatcould cause actual results to differ materially from the expectations reflectedin the forward-looking statements include, but are not limited to, any of thefollowing in the jurisdictions in which BPZ or its subsidiaries are doingbusiness:  Market conditions,uncertainties inherent in oil and gas production operations and estimatingreserves, unexpected future capital expenditures, the timing and extent ofchanges in commodity prices for crude oil, natural gas and related products,currency exchange

 

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rates, interest rates, inflation, the availabilityof goods and services, drilling and other operational risks, satisfaction ofwell testing period requirements, successful installation of required permanentprocessing facilities, receipt of all required permits, successful installationand operation of the new turbines, availability of capital resources, successof our operational risk management activities, governmental relations, legislativeor regulatory changes, political developments, acts of war and terrorism.  A more detailed discussion on risks relatingto the oil and natural gas industry and to our Company is included in ourAnnual Report on Form 10-K for the year ended December 31, 2009, asamended.

 

In light of these risks,uncertainties and assumptions, we caution the reader that these forward-lookingstatements are subject to risks and uncertainties, many of which are beyond ourcontrol, which could cause actual events or results to differ materially fromthose expressed or implied by the statements. All subsequent written and oral forward-looking statements attributableto us or persons acting on our behalf are expressly qualified in their entiretyby the cautionary statements.  Weundertake no obligations to update or revise our forward-looking statements,whether as a result of new information, future events or otherwise.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

Theprimary objective of the following information is to provide forward-lookingquantitative and qualitative information about our potential exposure to marketrisks.  The term “market risk” refers tothe risk of loss arising from adverse changes in interest rates, oil andnatural gas prices and foreign currency exchange rates.  The disclosures are not meant to be preciseindicators of expected future losses, but rather indicators of reasonablepossible losses.  This forward-lookinginformation provides indicators of how we view and manage our ongoing marketrisk exposures.  All of our market risksensitive instruments were entered into for purposes other than speculativetrading.

 

*Interest Rate Risk.*

 

As of March 31, 2010, we had long-term debt andcapital lease obligations of approximately $155.8 million and currentmaturities of long-term debt and capital lease obligations of approximately $6.9million, consisting of capital lease obligations for barges and productionequipment and loans for office furniture.

 

The $15.0million reserve-based lending facility is variable rate debt and bears interestat an approximate rate of LIBOR plus 2.75%. The variable rate debt exposes us to the risk ofincreased interest expense in the event of increases in short-term interestrates. If the variable interest rate were to increase by 1% from December 2009levels, interest expense would increase by approximately $0.2 millionannually. The carrying value of the variable interest rate debt approximatesfair value as it bears interest at current market rates.

 

The $170.9 million of 2015 Convertible Notes are ourgeneral senior unsecured obligations and bear a fixed interest rate of6.50% per year and whose interestpayments are due on March 1 and September 1 of each year, beginningon September 1, 2010.  The 2015 Convertible Notes mature on March 1,2015. As the interest rate on this debt is fixed, we do not expect asignificant change in the market interest rate to impact the interest on thisterm debt.

 

The capital leaseobligation for the floating production, storage and offloading facility(“FPSO”) andtransportation barges began in August 2007 and is set to expire in May 2014.Lease payments are variable based on the working status of the barges, with apurchase option of $3.0 million in May 2012, $2.0 million in May 2013,and required to be purchased by us for $1.0 million in May 2014.  Theimputed interest rate necessary to reduce the net minimum lease payments topresent value over the lease term is 34.9%. The capital lease obligation forthe production equipment on board the FPSO barge, the Namoku, is set to expirein June 2010, and contains a purchase option at the end of twelve monthsand another at the end of 24 months, and stipulates an interest rate of18.0%.  We have two additional loans for office equipment containing aterm of 60 months and bearing fixed interest rates of 5.94% and 9.44%,respectively, with principal and interest payments due on a monthly basis.

 

In November 2009, we entered into a capital leaseagreement for a construction barge, the Don Fernando, to assist us in ouroffshore construction projects. The capital lease asset and correspondingliability was recorded at $7.0 million, which represents the present value ofthe minimum lease payments, or the aggregate fair market value of theassets.  At the end of the two year leasethe title to the barge transfers to us. We accounted for the lease agreement in accordance with ASC Topic 840, “Leases”,previously accounted for under SFAS No. 13, “Accounting for Leases (AsAmended)”. Under the guidance, the lease agreement is accounted for as acapital lease and the imputed interest rate necessary to reduce the net minimumlease payments to present value over the lease term is 22.4%.

 

We do not expect a significant change in the market interestrate to impact the interest on our term debt.  However, significantchanges in market interest rates may significantly affect the level offinancing that will be structured with respect to our projects in Peru.

 

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*Commodity Price Risk*

 

With respect to our oil and gas business, anyrevenues, cash flow, profitability and future rate of growth we achieve will begreatly dependent upon prevailing prices for oil and gas.  Our ability tomaintain or increase our borrowing capacity and to obtain additional capital onattractive terms is also expected to be dependent on oil and gas prices. Historically, oil and gas prices and markets have been volatile and are likelyto continue to be volatile in the future.  Prices for oil and gas aresubject to potentially wide fluctuations in response to relatively minorchanges in supply of and demand for oil and gas, market uncertainty, and avariety of additional factors that are beyond our control.

 

Lower oil and natural gas prices may not only decreaseour revenues on a per unit basis, but may also reduce the amount of oil andnatural gas we can produce economically, if any.  A substantial orextended decline in oil and natural gas prices may materially affect our futurebusiness, financial condition, results of operations, liquidity and borrowingcapacity, and may require a reduction in the carrying value of our oil and gasproperties.  While our revenues may increase if prevailing oil and gasprices increase significantly, exploration and production costs and acquisitioncosts for additional properties and reserves may also increase.

 

With respect to our planned electricity generationbusiness, the price we can obtain for the sale of power may not rise at thesame rate, or may not rise at all, to match a rise in the cost to produce andtransport gas reserves to our initial 135MW power plant in Caleta Cruz. Prices for both electricity and natural gas have been very volatile in the pastyear and have increased significantly over the past two years.  Theprofitability of this business depends in large part on the difference betweenthe price of power and the price of fuel used to generate power, or “sparkspread.”

 

*Foreign Currency Exchange Rate Risk*

 

The U.S. Dollar is the functional currency for ouroperations in both Peru and Ecuador.  Ecuador has adopted the U.S. Dollaras its official currency.  Peru, however, uses its local currency, NuevoSol, in addition to the U.S. Dollar, and therefore, our financial results aresubject to favorable or unfavorable fluctuations in the exchange rate andinflation in that country.  Transaction differences have been nominalto-date but are expected to increase as our activities in Peru continue toescalate.  For both the three months ended March 31, 2010 and 2009,foreign currency exchange rate gains and losses were not material.

 

**Item 4. Controls and Procedures**

 

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

 

As of the end of the period covered by this report, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) ofthe Exchange Act.  Based upon thatevaluation our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures as defined in Rule 13a-15(e) ofthe Exchange Act were effective as of the end of the period covered by thisreport to ensure that information required to be disclosed by the Company inthe reports that the Company files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms.  Our disclosure controls and proceduresinclude controls and procedures designed to ensure that information required tobe disclosed in reports filed or submitted under the Exchange Act isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate, to allowtimely decisions regarding required disclosure.

 

 

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

 

During the quarter ended March 31, 2010, therewas no change in internal control over financial reporting that materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.

 

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**PART II**

 

**Item 1. Legal Proceedings**

 

See Note 16, “Legal Proceedings”, of the Notes to Unaudited Consolidated Financial Statementsincluded in this Form 10-Qand Item 3 of Part I of our Annual Report on Form 10-K for theyear ended December 31, 2009, as amended, for a discussion of legalproceedings, which are incorporated into this Part II, Item 1. “LegalProceedings” by reference.

 

**Item 1A. Risk Factors**

 

Item 1A, “Risk Factors” of our Annual Report on Form 10-Kfor the year ended December 31, 2009, as amended, includes a detaileddiscussion of our risk factors.  For thethree months ended March 31, 2010, there are no material changes in ourrisk factors as previously described in our Annual Report on Form 10-K.

 

**Item 6. Exhibits**

 
| 31.1   |   | Certification  of Chief Executive Officer pursuant to Section 302 of the Sarbanes -  Oxley Act of 2002. (Filed herewith)                                                     |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                              |
| 31.2   |   | Certification  of Chief Financial 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted  pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. (Filed  herewith) |

 

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**SIGNATURES**

 

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

 
|     | BPZ RESOURCES, INC.                                |
|----------|----------------------------------------------------|
|     |                                               |
|     |                                               |
|     | Date: May 10, 2010                            | /s/  MANUEL PABLO ZÚÑIGA-PFLÜCKER |
|     | Manuel Pablo Zúñiga-Pflücker        |
| * * | *President, Chief Executive Officer  and Director* |
|          |                                                    |  |

 

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