Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

**(Mark One)**

** **

| **x**                                                        | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|--------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                   | ** ** | ** **                                                                                               |
| **For the quarterly period ended:  September 30, 2008** |
| ** **                                                   | ** ** | ** **                                                                                               |
| **or**                                                       |
| ** **                                                   | ** ** | ** **                                                                                               |
| **o**                                                        | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition periodfrom         to         **

 

**CommissionFile Number: 001-12697**

 

**BPZRESOURCES, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **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)

 

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

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer, or a smaller reportingcompany. See definitions of “large accelerated filer,” “accelerated filer,” and“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 

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

 

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

 

Yes o No x

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date:

 

Asof October 31, 2008, there were 78,779,140 shares of common stock, no parvalue, outstanding.

 

 

 

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Tableof Contents

 

**TABLE OF CONTENTS**

 
|            | **PART I**                                                                             | ** ** | ** ** |
|------------|---------------------------------------------------------------------------------------------|------------|------------|
|       |                                                                                        |       |       |
| 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                                 |       | 34         |
|       |                                                                                        |       |       |
| Item 4.    | Controls and  Procedures                                                                    |       | 36         |
|       |                                                                                        |       |       |
| ** ** | **PART II**                                                                            | ** ** | ** ** |
|       |                                                                                        |       |       |
| Item 1.    | Legal  Proceedings                                                                          |       | 36         |
|       |                                                                                        |       |       |
| Item 1A.   | Risk Factors                                                                                |       | 36         |
|       |                                                                                        |       |       |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       | 38         |
|       |                                                                                        |       |       |
| Item 3.    | Defaults Upon Senior Securities                                                             |       | 38         |
|       |                                                                                        |       |       |
| Item 4.    | Submission  of Matters to a Vote of Security Holders                                        |       | 38         |
|       |                                                                                        |       |       |
| Item 5.    | Other Information                                                                           |       | 38         |
|       |                                                                                        |       |       |
| Item 6.    | Exhibits                                                                                    |       | 38         |
|       |                                                                                        |       |       |
| ** ** | **SIGNATURES**                                                                              |       |       |

 

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**PART I**

 

# **Item 1. Financial Statements**

#  

**BPZ Resources, Inc. and Subsidiaries**

**ConsolidatedBalance Sheets**

** **
| ** **                                                                                                                                                                        | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                        | ** ** | **2008**               | ** **  | **2007**              | ** ** |
| ** **                                                                                                                                                                        | ** ** | **(Unaudited)**        | ** **  | **(Audited)**         | ** ** |
| **ASSETS**                                                                                                                                                                        |       |                   |        |                  |       |
|                                                                                                                                                                              |       |                   |        |                  |       |
| Current assets:                                                                                                                                                                   |       |                   |        |                  |       |
| Cash and cash equivalents                                                                                                                                                         |       | $                      | 8,526,661   |                  | $          | 7,514,188 |   |
| Restricted cash                                                                                                                                                                   |       | —                 |        | 1,013,152             |       |
| Accounts receivable                                                                                                                                                               |       | 3,387,759              |        | 2,950,089             |       |
| Value added tax receivable                                                                                                                                                        |       | 10,128,253             |        | 7,496,547             |       |
| Inventory                                                                                                                                                                         |       | 5,560,199              |        | 3,372,883             |       |
| Prepaid and other current assets                                                                                                                                                  |       | 3,110,129              |        | 2,271,282             |       |
| Total current assets                                                                                                                                                              |       | 30,713,001             |        | 24,618,141            |       |
| Property, equipment and construction in  progress, net                                                                                                                            |       | 168,988,774            |        | 100,366,091           |       |
| Restricted cash                                                                                                                                                                   |       | 5,902,500              |        | 2,834,519             |       |
| Prepaid and other non-current assets                                                                                                                                              |       | —                 |        | 230,433               |       |
| Investment in Ecuador property, net                                                                                                                                               |       | 1,429,332              |        | 1,570,020             |       |
| Deferred income taxes                                                                                                                                                             |       | 1,910,202              |        | —                |       |
| Total assets                                                                                                                                                                      |       | $                      | 208,943,809 |                  | $          | 129,619,204 |   |
|                                                                                                                                                                              |       |                   |        |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                    |       |                   |        |                  |       |
|                                                                                                                                                                              |       |                   |        |                  |       |
| Current liabilities:                                                                                                                                                              |       |                   |        |                  |       |
| Accounts payable                                                                                                                                                                  |       | $                      | 23,799,462  |                  | $          | 11,774,316 |   |
| Accrued liabilities                                                                                                                                                               |       | 6,338,819              |        | 4,384,049             |       |
| Other liabilities                                                                                                                                                                 |       | 1,420,772              |        | 263,439               |       |
| Accrued interest payable                                                                                                                                                          |       | —                 |        | 458,279               |       |
| Current income taxes payable                                                                                                                                                      |       | 6,424,839              |        | —                |       |
| Current maturity of capital lease  obligations                                                                                                                                    |       | 10,178,548             |        | 6,188,668             |       |
| Total current liabilities                                                                                                                                                         |       | 48,162,440             |        | 23,068,751            |       |
| Asset retirement obligation                                                                                                                                                       |       | 433,072                |        | 273,048               |       |
| Long-term debt and capital lease  obligations                                                                                                                                     |       | 22,580                 |        | 15,537,293            |       |
| Total long-term liabilities                                                                                                                                                       |       | 455,652                |        | 15,810,341            |       |
| Commitments and contingencies (Note 15)                                                                                                                                           |       |                   |        |                  |       |
|                                                                                                                                                                              |       |                   |        |                  |       |
| Stockholders’ equity:                                                                                                                                                        |       |                   |        |                  |       |
| Preferred stock, no par value, 25,000,000  authorized; none issued and outstanding                                                                                                |       | —                 |        | —                |       |
| Common stock, no par value, 250,000,000  authorized; 78,745,890 and 73,914,471 shares issued and outstanding at  September 30, 2008 and December 31, 2007, respectively |       | 222,102,643            |        | 149,050,032           |       |
| Accumulated deficit                                                                                                                                                               |       | (61,776,926            | )           | (58,309,920           | )          |
| Total stockholders’ equity                                                                                                                                                   |       | 160,325,717            |        | 90,740,112            |       |
| Total liabilities and stockholders’ equity                                                                                                                                   |       | $                      | 208,943,809 |                  | $          | 129,619,204 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

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**BPZ Resources, Inc. and Subsidiaries**

**Consolidated Statements ofOperations**

**(Unaudited)**

** **
| ** **                                                              | ** ** | **Three Months  Ended September 30,** | ** ** | **Nine Months  Ended September 30,** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                              | ** ** | **2008**                                             | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenue                                                                 |       | $                                                    | 33,440,330 |                                                | $          | — |   | $ | 44,843,046 |   | $ | — |   |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Operating and administrative expenses:                                  |       |                                                 |       |                                                |       |   |   |   |   |
| General and administrative                                              |       | 10,406,515                                           |       | 5,574,985                                           |       | 28,644,083 |   | 12,437,516 |   |
| Lease operating expense                                                 |       | 3,582,490                                            |       | —                                              |       | 6,942,112 |   | — |   |
| Geological, geophysical and engineering                                 |       | 210,731                                              |       | 1,955,155                                           |       | 507,342 |   | 3,925,406 |   |
| Depreciation, depletion and amortization  expense                       |       | 5,673,404                                            |       | 56,651                                              |       | 7,946,772 |   | 163,437 |   |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Total operating expenses                                                |       | 19,873,140                                           |       | 7,586,791                                           |       | 44,040,309 |   | 16,526,359 |   |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Operating profit/(loss)                                                 |       | 13,567,190                                           |       | (7,586,791                                          | )          | 802,737 |   | (16,526,359 | ) |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Other income (expense):                                                 |       |                                                 |       |                                                |       |   |   |   |   |
| Income/(loss) from investment in Ecuador property,  net of amortization |       | 153,104                                              |       | 180,382                                             |       | 659,312 |   | (50,457 | ) |
| Interest expense                                                        |       | —                                               |       | (2,939                                              | )          | — |   | (4,104 | ) |
| Interest income                                                         |       | 10,005                                               |       | 256,557                                             |       | 206,499 |   | 754,304 |   |
| Net loss on sale of asset                                               |       | —                                               |       | —                                              |       | — |   | (8,985 | ) |
| Other income/(expense)                                                  |       | (68,146                                              | )          | (17,730                                             | )          | 155,847 |   | 27,059 |   |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Total other income                                                      |       | 94,963                                               |       | 416,270                                             |       | 1,021,658 |   | 717,817 |   |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Income/(loss) before income taxes                                       |       | 13,662,153                                           |       | (7,170,521                                          | )          | 1,824,395 |   | (15,808,542 | ) |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Income taxes provision/(benefit)                                        |       | 5,050,821                                            |       | (11,301                                             | )          | 5,291,401 |   | 39,001 |   |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Net income/(loss)                                                       |       | $                                                    | 8,611,332  |                                                | $          | (7,159,220 | ) | $ | (3,467,006 | ) | $ | (15,847,543 | ) |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Basic net earnings/(loss) per share                                     |       | $                                                    | 0.11       |                                                | $          | (0.10 | ) | $ | (0.05 | ) | $ | (0.23 | ) |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted net earnings/(loss) per share                                   |       | $                                                    | 0.11       |                                                | $          | (0.10 | ) | $ | (0.05 | ) | $ | (0.23 | ) |
|                                                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average common shares outstanding:                             |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                   |       | 78,574,955                                           |       | 72,222,433                                          |       | 76,933,067 |   | 67,771,664 |   |
| Diluted                                                                 |       | 80,323,207                                           |       | 72,222,433                                          |       | 76,933,067 |   | 67,771,664 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

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**BPZResources, Inc. and Subsidiaries**

**ConsolidatedStatements of Cash Flows**

**(Unaudited)**

** **
| ** **                                                                              | ** ** | **Nine months ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                              | ** ** | **September 30,**          | ** ** |
| ** **                                                                              | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                                   | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net loss                                                                                |       | $                               | (3,467,006 | ) | $ | (15,847,543 | ) |
| Adjustments to reconcile net loss to net  cash provided/(used) by operating activities: |       |                            |       |   |   |
| Stock-based compensation                                                                |       | 13,419,317                      |       | 4,712,874 |   |
| Depreciation, depletion and amortization  expense                                       |       | 7,946,772                       |       | 163,437 |   |
| Deferred income taxes                                                                   |       | (1,910,194                      | )          | — |   |
| Net loss on the retirement of assets                                                    |       | —                          |       | 8,985 |   |
| Amortization of investment in Ecuador  property                                         |       | 140,688                         |       | 140,688 |   |
| Changes in operating assets and  liabilities:                                           |       |                            |       |   |   |
| Increase in accounts receivable                                                         |       | (437,670                        | )          | — |   |
| Increase in value added tax receivable                                                  |       | (2,631,706                      | )          | (5,636,855 | ) |
| Increase in inventory                                                                   |       | (1,926,884                      | )          | (1,751,167 | ) |
| Decrease in restricted cash                                                             |       | 1,013,152                       |       | — |   |
| Increase in other assets                                                                |       | (838,847                        | )          | (568,310 | ) |
| Increase (decrease) in accounts payable                                                 |       | 12,025,146                      |       | 1,957,428 |   |
| Increase in accrued liabilities                                                         |       | 1,496,491                       |       | 1,869,152 |   |
| Increase in other liabilities                                                           |       | 1,157,333                       |       | 103,546 |   |
| Current income taxes payable                                                            |       | 6,424,840                       |       | — |   |
| Net cash provided by/(used by) operating  activities                                    |       | 32,411,432                      |       | (14,847,765 | ) |
| Cash flows from investing activities:                                                   |       |                            |       |   |   |
| Property and equipment additions                                                        |       | (67,196,266                     | )          | (38,650,428 | ) |
| Restricted cash                                                                         |       | (3,067,981                      | )          | (845,000 | ) |
| Net cash used by investing activities                                                   |       | (70,264,247                     | )          | (39,495,428 | ) |
| Cash flows from financing activities:                                                   |       |                            |       |   |   |
| Borrowings                                                                              |       | 2,819,080                       |       | — |   |
| Repayments of borrowings                                                                |       | (8,087,077                      | )          | (12,902 | ) |
| Proceeds from the exercise of stock  warrants                                           |       | 750,000                         |       | — |   |
| Proceeds from exercise of options, net                                                  |       | 2,458,592                       |       | 2,691,960 |   |
| Proceeds from sale of common stock, net                                                 |       | 40,924,702                      |       | 36,918,146 |   |
| Net cash provided by financing activities                                               |       | 38,865,297                      |       | 39,597,204 |   |
| Net increase/(decrease) in cash and cash  equivalents                                   |       | 1,012,482                       |       | (14,745,989 | ) |
| Cash and cash equivalents at beginning of  period                                       |       | 7,514,188                       |       | 25,324,233 |   |
| Cash and cash equivalents at end of period                                              |       | $                               | 8,526,670  |   | $ | 10,578,244 |   |
| Supplemental cash flow information:                                                     |       |                            |       |   |   |
| **Cash paid for:**                                                                      | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Interest                                                                                |       | $                               | 2,901,982  |   | $ | 54,104 |   |
| Income tax                                                                              |       | 776,764                         |       | 39,001 |   |
| **Non — cash items:**                                                              | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Conversion of long-term debt to common  stock                                           |       | $                               | 15,500,000 |   | $ | — |   |
| Purchase and additions to equipment with  the issuance of a capital lease  obligation   | ** ** | 9,243,164                       | ** ** | 6,180,679 | ** ** |
| Issuance of common stock for subscription  receivable                                   |       | —                          |       | 942,300 |   |
| Depletion capitalized to production  inventory, net                                     |       | 260,432                         |       | — |   |
| Interest capitalized to construction in  progress                                       |       | 230,433                         |       | 362,592 |   |
| Depreciation on support equipment  capitalized to property & equipment         |       | 658,474                         |       | 359,434 |   |
| Asset retirement obligation capitalized to  property and equipment                      |       | 134,287                         |       | — |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

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**BPZ Resources, Inc. and Subsidiaries**

**Notes ToConsolidated Financial Statements**

**(Unaudited)**

 

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

 

**Organization**

 

BPZ Resources, Inc., a Texas corporation(the “Company” or “BPZ”), is based in Houston, Texas with offices in Lima, Peruand Quito, Ecuador.  The Company isfocused on the exploration, development and production of oil and natural gasin Peru and Ecuador.  It also intends toutilize part of its future natural gas production as a supply source for thecomplementary development of a Company owned gas-fired power generationfacility.

 

The Company maintains a Peruvian subsidiary throughits wholly-owned subsidiary BPZ Energy, Inc., a Texas corporation (“BPZ –Texas”).  Currently, it has exclusiverights and license agreements for oil and gas exploration and productioncovering a total of approximately 2.4 million acres, in four blocks, innorthwest Peru.  The license contractscover 100% ownership of Block Z-1 (739,205 acres), Block XIX (472,860 acres),Block XXII (948,000 acres) and Block XXIII (248,000 acres).  The Block Z-1 contract was signed in November 2001,the Block XIX contract was signed in December 2003 and Blocks XXII andXXIII contracts were both signed in November 2007.  The Company’slicense contracts provide for an initial exploration period of seven tothirteen years for Block Z-1 and seven to ten years for Blocks XIX, XXII andXXIII.  In addition, the contracts require that the Company conductspecified activities on the properties during this period.  If the exploration activities are successful,the total contract term can extend up to 30 years for oil exploration andproduction and up to 40 years for gas exploration and production.

 

Additionally, through the Company’s wholly-ownedsubsidiary, SMC Ecuador Inc., a Delaware corporation, and its registeredbranch in Ecuador, it owns a 10% non-operated working interest in an oil andgas producing property, Block 2, located in the southwest region of Ecuador(the “Santa Elena Property”).  Thelicense agreement covering the property extends through May 2016.

 

The Company is in theinitial stages of developing and producing its oil and natural gasreserves.  To date, its activities in Peru have been primarily limited toanalysis and evaluation of technical data on its properties, preparation of thedevelopment plans for the properties, including detailed engineering and designof the power plant and gas processing facilities, refurbishment of two of itsoffshore platforms, procuring machinery and equipment for an extended drillingcampaign, obtaining all necessary environmental and operating permits, bringingproduction on-line and securing the required capital and financing to conductthe current plan of operation.

 

**OilDevelopment**

 

***CorvinaField***

 

TheCompany started producing oil from its recent discoveries at the CX-11platform, located in the Corvina Field in its offshore Block Z-1, under anextended well testing program which began on November 1, 2007.  TheCorvina field consists of 47,000 acres in water depths of less than 200feet.  The Company is currentlyconcentrating its drilling efforts on West Corvina, which consists of 3,500acres and it has completed a total of three oil producing wells, the CX11-21XD,the CX11-18XD and the CX11-14D.  The oilis delivered by barge to the Petroperu refinery in Talara, locatedapproximately 100 miles south of the platform.  The remainder is kept in productioninventory until such time it is delivered to the refinery.

 

On October 24, 2007, the Company’s former primary marinetransportation contractor entered into two short-term agreements with thecommercial division of the Peruvian Navy to lease two tankers to transport oilto market.  On January 30, 2008, oneof the tankers, the Supe, sank after catching fire.  At the time of the incident, the tankercontained approximately 1,300 barrels of oil, most of which burned in the fire.No Company employees were injured. Official environmental impact assessmentsconcluded that environmental issues have been adequately controlled.Even though no civil claims have been asserted against the Company as a resultof the Supe incident, the Company believes that it, as a contracting party, andits third party marine contractor, as the time charterer of the Supe, may havelimited exposure to civil liability resulting from the Supe incident. However, the Company considers any such liability to be remote and that such limitedexposure, while unknown at this time, will not have a material effect on itsfinancial statements.  As a resultof the incident, the Company’s operations were voluntarily suspended at theCX-11 platform.

 

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OnMarch 14, 2008, the Company was notified by the OrganismoSupervisor de la Inversión en Energía y Mineria (“OSINERGMIN”)  thegovernment regulatory agency in Peru responsible for monitoring industrialsafety, that it could resume drilling and testing operations at the CX-11platform allowing the Company to begin testing the CX11-18XD well.  Three drill stem tests were conducted in theUpper Zorritos formation.  The first twodrill stem tests targeted the lower sands in zones that had not previously beentested.  The third drill stem testtargeted sands that had tested oil in the Company’s CX11-21XD well.  The Company began producing from the 18XDwell in May 2008 and, on June 9, 2008, the Company received theclearance needed to transport oil from the CX-11 platform to the nearby Talararefinery by the corresponding Peruvian environmental agency.  In addition, its floating production storageand offloading (“FPSO”) vessel was placed in position near the CX-11 platformand is currently receiving production from the platform.

 

Uponcompletion of the CX11-18XD well referred to above, the Company spuddedthe CX11-20XD well in May 2008.  TheCX11-20XD well is positioned higher up in the geologic structure from theCX11-21XD well.  The well has beenpositioned to further develop the top gas sands found in the previously drilled21XD well, the oil sands currently producing in the 21XD and 18XD wells, theoil sands encountered and briefly tested in the 18XD well during the initialdrill-stem test number one, as well as sands found in the 14D well.  Thewell tested positive for oil in quantities that the Company believes to becommercially producible.  The Company completedtwo drill stem tests on four sets of oil sands in the well.  Currently, the Company intends to completethe CX11-20XD well as an oil-producing well under the extended well testingprogram currently ongoing at the Corvina field. However, because the wellcrosses sands which tested positive for what the Company believes to beeconomic quantities of gas in both the 21XD and 18XD wells, it intends tore-complete the CX11-20XD well to allow the well to produce both gas and oilwhen the gas is needed for the Company’s gas-to-power project.

 

TheCompany intends to spud the CX11-15D well by mid-November 2008.  The Company expects this well to takeapproximately 90 days to reach total depth, and to be tested and completed inearly 2009.  The 15D well represents thefinal well to be drilled from the CX-11 platform under the initial Corvinadrilling program.  Upon completion of theCX11-15D well, the Company intends to focus its drilling efforts on theAlbacora Field.

 

***Albacora Field***

 

TheAlbacora Field is located in the northern part of the Company’s offshore BlockZ-1.  It consists of approximately 6,000acres and, like the Corvina Field, Albacora is located in water depths of lessthan 200 feet. Once the drilling rig has been moved from Corvina and setin place on top of the Albacora A-1 platform, which is currently beingrefurbished, the Company plans to drill the A-14XD well, a twin well toAlbacora’s 8-X-2 discovery well., This first well in Albacora will qualify asan exploratory well as the Company plans on testing the prospective LowerZorritos formation sands.  The 8-X-2discovery well, drilled 35 years ago, tested oil and gas in the upper Zorritosformation sands at quantities the Company believes to be commerciallyproducible.  The Company’s initial drillingplans in Albacora are to drill at least six new wells and then recomplete threeoil wells currently shut-in at the A-1 platform.

 

**Gas-to-PowerProject**

 

The Corvina Gas-to-Powerproject entails the installation of a 10-mile gas pipeline from the CX-11 platformto shore, construction of gas processing facilities and an approximately 135megawatt (“MW”) simple-cycle electric generating plant.  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 360 MW of power.In order to support the Company’s proposed electric generation project, itcommissioned an independent power market analysis for the region. The Peruvianelectricity market is deregulated and power is transported through aninterconnected national grid managed by the Committee for Economic Dispatchingof Electricity (known as COES). Based on this study, the Company believes itwill be able to sell economic quantities of electricity from the initial 135 MWpower plant. The market study also indicates that there may be futureopportunities for the Company to generate and sell significantly greatervolumes of power into the Peruvian and possibly Ecuadorian power markets.  The Company plans to own 100% of the powerplant. Accordingly, its revenues from the natural gas delivered to the powerplant will be derived from the sale of electricity, which is currentlyprojected to commence mid-2010, though this schedule is subject to many factorsoutside its control, including obtaining all necessary financing and equipment.  No assurance can be given that the Companycan meet this schedule.

 

The Company is currentlyworking on securing and finalizing funding for its gas to power initiativescomprised of approximately $120 million of senior debt to be syndicated by theInternational Finance Committee (“IFC”), which is expected to close by mid2009. This financing will be subject to identification of the lending syndicatemembers and subsequent negotiation and approval of the necessary loandocumentation.

 

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OnSeptember 26, 2008, the Company through its power generation subsidiary,Empresa Eléctrica Nueva Esperanza, SRL, entered into a $51.5 million contractfor purchase of equipment and services (the “Agreement”) with GE Packaged Power, Inc.and GE International, Inc. Sucursal de Peru, which are part of GE Energy’saeroderivative business.  The Agreement obligates the Company to purchasethree LM6000 gas-fired turbines, with an option to purchase a fourth unit, andrequires an initial down payment of $5.1 million. Monthly progresspayments of $1.1 million will commence in October 2008 for the first unit,$2.3 million in November 2008 for both the first and second units, $3.4million in December 2008 through September of 2009 for all threeunits, $2.3 million in October of 2009 for two units and $1.1 million in November of2009 for the final unit.  A final payment of $1.7 million per unit ($5.1million total) is due five days after the issuance of the seller’s Notice of Readinessto Ship for each unit.  The contract also contains an option to purchaseone additional unit for $18.2 million.  Each turbine will have ageneration capacity of 45 megawatts, with excess capacity of approximately5%.  Delivery of the three units is scheduled for the fourth quarter2009.  See Note 15, “Commitments andContingencies” for further detail regarding the Agreement.

 

Initially,the Company expects that funding of payments due under the Agreement may comefrom an on-lending arrangement (loans between the Company’s subsidiaries)contained in the $215 million reserve-based lending facility.  After the $120 million project financingmentioned above is closed and funded as expected, any amounts borrowed underthe on-lending arrangement from the $215 million reserve-based lending facilitywill be repaid from those proceeds.  Fora more detailed description of the on-lending arrangement from the $215 millionreserve-based lending facility, see Note 9, “Long-Term Debt and Capital LeaseObligations”.

 

**Basis of Presentation and Principles ofConsolidation**

 

The Company’s unaudited consolidated financial statements includedherein have been prepared pursuant to the rules and regulations of theSecurities and Exchange Commission as they pertain to Form 10-Q.  Accordingly, certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States have beencondensed or omitted pursuant to such rules and regulations. The unauditedfinancial statements reflect all adjustments which are, in the opinion ofmanagement, necessary for a fair presentation of the financial position andresults of operations for the interim periods presented on a basis consistentwith the annual audited financial statements. All such adjustments are of a normal recurring nature.  The Company believes that the disclosurescontained herein are adequate to make the information presented notmisleading.  The consolidated balancesheet at December 31, 2007, as presented herein, is derived from the December 31,2007 audited consolidated financial statements. These interim financial statements should be read in conjunction withthe consolidated financial statements and notes thereto included in theCompany’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2007.  The results of operations for interim periodsare not necessarily indicative of the results to be expected for the full year.

 

***Reclassifications***

 

Certain reclassifications of prior yearbalances have been made to conform such amounts to corresponding 2008classifications.  These reclassificationshave no impact on net income.

 

**Summary of Significant Accounting Policies**

 

TheCompany has provided a summary discussion of significant accounting policies,estimates and judgments in Note 1 to the Notes to the Consolidated FinancialStatements included in its Annual Report on Form 10-K, as amended, for theyear ended December 31, 2007.

 

***Principlesof Consolidation***

*** ***

Our consolidated financial statements include the accountsof the Company and its wholly owned subsidiaries and branch offices.  All intercompany balances and transactionshave been eliminated.

 

**Recent Accounting Pronouncements**

 

In December 2007, the FASB issued SFAS No. 141(revised 2007), *Business Combinations*(“SFAS No. 141(R)”), which replacesFASB Statement No. 141. SFAS No. 141(R) establishes principlesand requirements for how an acquirer recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired.  SFAS No. 141(R) also establishesdisclosure requirements that will enable users to evaluate the nature andfinancial effects of the business combination. SFAS No. 141(R) is effective for acquisitions that occur in anentity’s fiscal year that begins after December 15, 2008, which will bethe Company’s fiscal year 

 

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2009.  The Company does not expect the adoption ofSFAS No. 141(R) to have a material impact on its consolidatedfinancial position, results of operations or cash flows.

 

InSeptember 2006, the FASB issued SFAS No. 157 — *Fair ValueMeasurement* (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles, and expandsdisclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued forperiods beginning after November 15, 2007. SFAS No. 157 applies under other accounting pronouncements thatrequire or permit fair value measurements, the FASB having previously concludedin those accounting pronouncements that fair value is the relevant measurementattribute.  Accordingly, SFAS No. 157does not require any new fair value measurements.  However, for some entities, the applicationof this SFAS No. 157 will change current practice.  The definition of fair value focuses on theprice that would be received to sell the asset or paid to transfer theliability (an exit price), not the price that would be paid to acquire theasset or received to assume the liability (an entry price).  SFAS No. 157 emphasizes that fair valueis a market-based measurement, not an entity-specific measurement.  In February 2008, the FASB issued FASBStaff Position (FSP) SFAS 157-2 (“SFAS 157-2”) which defers the effective dateof SFAS No. 157 for non-financial assets and liabilities that are notrecorded at fair value on a recurring basis until periods beginning after November 15,2008.  The Company adopted SFAS No. 157effective January 1, 2008, except for those provisions permitted to bedelayed by SFAS 157-2.  Accordingly, theCompany has not applied the provisions of SFAS No. 157 to non-financialassets and liabilities initially measured at fair value.  In general, fair value measurements anddisclosures are made in accordance with the provisions of SFAS No. 157.  The adoption of SFAS No. 157 had noimpact on our consolidated financial position, results of operations or cashflows.

 

In February 2007, FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and FinancialLiabilities—Including an Amendment of FASB Statement No. 115*(“SFAS No. 159”).  This standardpermits an entity to choose to measure many financial instruments and certainother items at fair value.  Most of theprovisions in SFAS No. 159 are elective; however, the amendment to FASBStatement No. 115, Accounting for Certain Investments in Debt and EquitySecurities, applies to all entities with available-for-sale and tradingsecurities.  SFAS No. 159 iseffective for fiscal years beginning after November 15, 2007.  On January 1, 2008, the Companyadopted SFAS No. 159 and elected not to measure any of its currently eligibleassets and liabilities at fair value.

 

In December 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in ConsolidatedFinancial Statements—an Amendment of ARB No. 51*.  (“SFAS No. 160”) requires thataccounting and reporting for minority interests will be recharacterized asnoncontrolling interests and classified as a component of equity.  SFAS No. 160 also establishes reportingrequirements that provide sufficient disclosures that clearly identify anddistinguish between the interests of the parent and the interests of thenoncontrolling owners.  SFAS No. 160applies to all entities that prepare consolidated financial statements, exceptnot-for-profit organizations, but will affect only those entities that have anoutstanding noncontrolling interest in one or more subsidiaries or thatdeconsolidate a subsidiary.  Thisstatement is effective for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of SFAS No. 160 to have amaterial impact on its consolidated financial position, results of operationsor cash flows.

 

***On December 21, 2007, the SEC released Staff AccountingBulletin, (“SAB 110”) “Share-Based Payment” which will no longer allow the useof the “simplified” method to estimate the expected terms as on the variablesto determine the fair value of share-based payments.  With a limited number of exceptions,companies can continue to use the simplified method.  However, doing so requires the types ofgrants for which the simplified method is used if not for all grants, and theperiods for which the simplified method is being used.  The adoption of this Staff AccountingBulletin had no material impact on our consolidated financial position, resultsof operations, or cash flows.***

*** ***

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

*** ***

InJune 2008, the FASB issued Staff Position No. EITF 03-6-1“Determining Whether Instruments Granted in Share-Based Payment TransactionsAre Participating Securities,” (“FSP EITF 03-6-1”) which provides that unvestedshare-based payment awards that contain nonforfeitable rights to dividends ordividend equivalents (whether paid or unpaid) are participating securities and,therefore, need to be included in the earnings allocation in computing earningsper share under the two class method. FSP EITF 03-6-1 is effective for us on January 1,2009 and all prior-period EPS data (including any amounts related to interimperiods, summaries of earnings and selected financial data) will be adjustedretroactively to 

 

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conform to its provisions. Early applicationof FSP EITF 03-6-1 is not permitted. Although restricted stock awards meet thisdefinition, the Company does not expect the application of FSP 03-6-1 to have asignificant impact on its reported earnings per share.

 

**Note 2 — Value Added Tax Receivable**

 

Value-addedtax (referred to as “IGV” in Peru) is generally imposed on goods and servicesat a rate of 19%.  Peru currently has anIGV early recovery program for companies during the exploration phase.  Under this program, IGV paid on theacquisition of certain goods and services used directly in hydrocarbonexploration activities can be recovered prior to a commercial discovery takingplace or production and revenue billings beginning.  Because the Company has oil sales, it is nolonger eligible for the IGV early recovery program on IGV receivables generatedafter November 2007.

 

The Company’s value added tax receivablebalance as of September 30, 2008 was approximately $10.1 million comparedto approximately $7.5 million at December 31, 2007.  Approximately $0.6 million and $3.7 millionhave been collected during the three and nine months ended September 30,2008, respectively, under the IGV early recovery program and approximately $5.5million and $6.5 million was offset by IGV payables generated by oil salesduring the three and nine months ended September 30, 2008,respectively.  As of September 30,2008, all IGV eligible to be received under the early recovery program has beencollected. The $10.1 million IGV receivable at September 30, 2008,referred to above, is not eligible for early recovery due to the initiation ofoil sales in November 2007. However, the $10.1 million will be recoverable against IGV payablesassociated with future oil sales under the normal IGV recovery process.

 

Asof September 30, 2008, the Company did not have any outstanding borrowingsunder a short-term credit facility issued by Peruvian Banks and collateralizedby IGV receivables eligible under the early recovery program.  See Note 9 “Long-Term Debt and Capital Lease Obligation”,included herein, for further discussion.

 

**Note 3 — Inventories**

 

Inventories consist primarily of tubular goods, accessories and spareparts for production equipment (“material inventory”), stated at the lower ofaverage cost or market.  The Company also maintains crude oilproduction inventories (“production inventory”) in storage barges.  Cost is determined on a weighted averagebasis based on production costs.

 

The balance inmaterial inventory at September 30, 2008 and December 31, 2007 was$4.9 million and $2.8 million, respectively. The increase is due to additional production and drilling activityprimarily related to the Corvina field.  In addition, there was approximately $699,437of production inventory on hand at September 30, 2008, consisting of29,546 barrels of oil at an estimated cost of $23.67 per barrel.  This is an increase from December 31,2007 which consisted of approximately 12,248 barrels of crude oil at anestimated cost of $548,391 or $44.77 per barrel.  The increase in inventory is mainly due totiming differences between each delivery of oil as well as an increased numberof oil deliveries during the quarter ended September 30, 2008 as comparedto the quarter ended December 31, 2007.

 

**Note4 — Prepaid and Other Current Assets**

 

Below is a summary of prepaid and other current assets as of September 30,2008 and December 31, 2007:

 
| ** **                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Prepaid expenses and other |       | $                      | 1,180,308  |                  | $          | 590,784 |   |
| Deposits                   |       | 88,878                 |       | 51,964                |       |
| Prepaid insurance          |       | 1,228,910              |       | 1,015,676             |       |
| Insurance receivable       |       | 612,033                |       | 612,033               |       |
| Interest receivable        |       | —                 |       | 825                   |       |
|                       |       | $                      | 3,110,129  |                  | $          | 2,271,282 |   |

 

Prepaid expenses and other are primarilyrelated to prepayments for drilling services, equipment rental and materialprocurement.  Deposits are primarily rentdeposits in connection with the Company’s offices in Houston and Peru.  Prepaid insurance consists of premiumsrelated to the Company’s operations as well as general liability and directorsand officer’s insurance policies.

 

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Insurance receivable is related to a navigation incident which causedthe BPZ-01 barge to be grounded on a sand bank in Talara Bay in northwest Peruduring the second mobilization trip to the Corvina platform in early August 2006.  As of September 30, 2008, the Companyexpects to file a total claim of approximately $712,000 for hull repairs withthe insurance carrier.  A deductible of$75,000 will be applied to this insurance claim when reimbursed.  The Company received proceeds from theunderwriter to cover a related claim regarding third party cargo that wasdamaged in the grounding incident. During the three months ended September 30, 2008, approximately$80,000 of insurance proceeds was received in connection with this claim.  A deductible of $25,000 was offset againstthe insurance proceeds received.  Thisamount is unrelated to the $712,000 hull claim described above as the proceedsfrom the cargo claim were passed on to the third party owner of the cargo thatwas damaged.  The hull claim will befinalized upon the dry docking of the vessel. Because of the delays caused by the drilling of the highly deviatedCX11-20XD well during the third quarter 2008, the dry dock of the BPZ-01 is scheduledduring the first quarter of 2009.  As of November 9,2008 the Company has not presented a final claim to its insurance carrier forthe barge repairs.

 

As a result of the delayed dry dock of theBPZ-01, the Company allowed the Certificate of Inspection from the U.S. CoastGuard to expire, thus prohibiting the BPZ-01 from transporting hazardous cargowithin U.S. federal waters.  Because theCompany does not intend to take the BPZ-01 out of Peruvian waters, it hasre-flagged the BPZ-01 and it is no longer subject to U.S. jurisdiction. See Note 15 “Commitments andContingencies”, included herein, for further discussion.

 

**Note 5 — Property, Equipment and Constructionin Progress**

 

Below is a summary of property, equipment and construction in progress as of September 30, 2008 and December 31, 2007:

 
| ** **                                                              | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                                              | ** ** | **2008**               | ** **  | **2007**              | ** ** |
| Construction in progress:                                               |       |                   |        |                  |       |
| Power plant and related equipment                                       |       | $                      | 11,528,579  |                  | $          | 3,486,309 |   |
| Platforms and wells, using the successful  efforts method of accounting |       | 64,544,938             |        | 25,220,425            |       |
| Pipelines and processing facilities                                     |       | 5,074,817              |        | 4,412,677             |       |
| Producing properties                                                    |       | 75,243,646             |        | 56,159,488            |       |
| Barge and related equipment                                             |       | 21,802,136             |        | 11,970,171            |       |
| Office equipment, leasehold improvements,  and vehicles                 |       | 1,558,191              |        | 1,040,613             |       |
| Accumulated depreciation, depletion and  amortization                   |       | (10,763,533            | )           | (1,923,592            | )          |
| Net property, equipment and construction in  process                    |       | $                      | 168,988,774 |                  | $          | 100,366,091 |   |

 

During the nine months ended September 30, 2008, the Companyincurred costs of approximately $77.7 million associated with its developmentinitiatives for the exploration and production of oil and natural gas reservesand the complementary development of proprietary gas-fired power generation ofelectricity for sale in Peru.

 

Of the incurred costs mentioned above, the Company incurred capitalexpenditures related to the drilling and testing of the CX11-18XD ofapproximately $19.0 million during the nine months ended September 30,2008.  The Company performed three drillstem tests of the CX11-18XD.  The three drill stem tests were conducted inthe Upper Zorritos formation.  The firsttwo drill stem tests targeted the lower sands in zones that had not previouslybeen tested.  The third drill stem testtargeted sands that had tested oil in the Company’s CX11-21XD well.  The Company began producing from the 18XDwell in May of 2008.

 

In addition, the Company spudded the CX11-20XD well in May 2008.  The CX11-20XD well is positioned higher upthe geologic structure from the CX11-21XD well. The well has been positioned to further develop the top gas sands foundin the previously drilled 21XD well, the oils sands currently producing in the21XD and 18XD wells, the oil sands encountered and briefly tested in the 18XDwell during the initial drill-stem test number one, as well as sands found inthe 14D well.  The well testedpositive for both gas and oil in quantities that the Company believes to becommercially producible.  The Companycompleted two drill stem tests on four sets of oil sands in the well.  Currently, the Company intends to completethe CX11-20XD well as an oil-producing well under the extended well testingprogram currently ongoing at the Corvina field. However, because the wellcrosses sands which tested positive for what the Company believes to be economicquantities of gas in both the 21XD and 18XD wells, it intends to re-completethe CX11-20XD well to allow the well to 

 

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produce both gas and oil when the gas is needed forthe Company’s gas-to-power project. Total capital expenditures incurred on this well for the nine monthsended September 30, 2008 is approximately$25.3 million.

 

TheCompany intends to spud the CX11-15D well by mid-November 2008.  The Company expects this well to takeapproximately 90 days to reach total depth, and to be tested and completed inearly 2009.  The 15D well represents thefinal well to be drilled from the CX-11 platform under the initial Corvinadrilling program.  Upon completion of theCX11-15D well, the Company intends to focus efforts on the Albacora fieldlocated in the northern part of its offshore Block Z-1.

 

TheCompany also incurred costs of approximately $9.3 million during the ninemonths ended September 30, 2008 for the installation of sea-bed pipelinesand a new mooring system as a result of placing the FPSO into service.  This new program should enable the Company toinitiate production in a more efficient manner, allowing for a betterunderstanding of the behavior and characteristics of the Corvina oil field.

 

In preparation forthe Company’s drilling campaign in Albacora, the Company performed well controlon the existing well heads located at the platform.  The Company incurred approximately $1.5million in well control costs to provide a safe environment to begin therefurbishment of the A-1 platform.

 

InFebruary 2008, the Company entered into a lease-purchase agreement toacquire a deck barge (“BPZ-02”), of approximately 330 feet in length, to assistin the platform refurbishment and drilling activities in the Albacora field aswell as to assist in future offshore drilling and development activities. In the near term, the BPZ-02 is being used to act as a tender assist for thePetrex drilling rig until it is moved to the Albacora field in first quarter2009.  During that time the BPZ-01 will be placed in dry-dock to repairdamages sustained when it ran aground in late 2006.  The acquisition ofthe BPZ-02 allows the Company better asset maintenance scheduling and will aidin the support of increased offshore exploration and developmentactivities.  The terms of the lease-purchase stipulate a 19% rate ofinterest (33% effective rate of interest) over a one-year term ending February 2009at which point, title to the BPZ-02 will transfer to the Company upon finalpayment of the lease.  The Company accounted for the transaction as aCapital Lease in accordance to SFAS 13, “Accounting For Leases (As Amended)”under the applicable criteria, title to the barge will transfer at the end ofthe lease period and, as a result, depreciation will be calculated over theeconomic life of the asset.  Leasepayments are fixed at $694,167 per month. The capital lease asset was recorded at approximately $7.0 million,which represents the present value of the minimum lease payments, or the fairmarket value of the asset.

 

Inaddition, the Company entered into a capital lease agreement for the productionequipment on board the FPSO.  The FPSO,the Namoku, as well as the storage barge, the Nu’uanu, are under a separatecapital lease agreement.  The capitallease for the production equipment commenced in June 2008, the date theequipment was put into service.  Thelease terms are variable and bear an interest rate of 18% based on theCompany’s incremental borrowing rate for similar equipment.  In accordance with the terms of the lease, abargain purchase option exists at the end of the lease.  As a result, depreciation will be calculatedover the economic life of the asset.  TheCompany recorded the capital lease at $2.4 million, which represents thepresent value of the minimum lease payments at the Company’s incrementalborrowing rate over the term of the lease, or the fair market value of theasset.

 

The Company continues to work on thedevelopment of a Company owned gas-fired power generation facility.  The Company incurred costs of approximately$3.6 million related to the drafting of certain design specifications for thepower plant during the nine months ended September 30, 2008.  In addition, on September 26,2008, the Company, through its subsidiary Empresa Eléctrica Nueva Esperanza,SRL, entered into a $51.5 million contract for purchase of equipment andservices (the “Agreement”) with GE Packaged Power, Inc. and GEInternational, Inc. Sucursal de Peru, which are part of GE Energy’saeroderivative business.  The Agreement obligates the Company to purchasethree LM6000 gas-fired turbines, with an option to purchase a fourth unit, andrequired an initial down payment of $5.1 million.  See Note 15 “Commitment and Contingencies”for further detail regarding the Agreement.

 

The Company also incurred costs for office equipment and leaseholdimprovements for its offices in Houston, Peru and Ecuador of approximately $0.3million and for the purchase of machinery and equipment used in operations inPeru of approximately $0.6 million.

 

In accordance with “successful efforts” method of accounting, theCompany capitalized approximately $245,062 and $658,474 of depreciation expensemainly related to the tender assist barges serving as support equipment, toconstruction in progress for the three and nine month period ended September 30,2008, respectively.  In addition, theCompany capitalized interest expense for the three and nine months ended September 30,2008 of approximately $892,727 and $2,901,982, respectively, to construction inprogress.

 

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**Note 6 — Asset Retirement Obligation**

 

The Company recorded an obligation for the plug and abandonment of theproducing oil wells, the CX11-21XD and the CX11-14D, in accordance with theprovisions of SFAS No 143 “Accounting for Asset Retirement Obligations”.  The Company incurred additions to its assetretirement obligations (“ARO”) as a result of the successful completion of theCX11-18XD well during the nine months ended September 30, 2008.

 

***Activity related to the Company’s ARO is as follows:***

 

| ** **                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2008**               | ** ** | **2007**              | ** ** |
|                                  |       |                   |       |                  |       |
| ARO as of the beginning of the period |       | $                      | 273,048    |                  | $          | — |   |
| Liabilities incurred during period    |       | 134,287                |       | 268,572               |       |
| Liabilities settled during period     |       | —                 |       | —                |       |
| Accretion expense                     |       | 25,737                 |       | 4,476                 |       |
| ARO as of the end of the period       |       | $                      | 433,072    |                  | $          | 273,048 |   |

 

**Note 7 — Investment in Ecuador Property**

 

The Company has an investment in an oil and gas property in Ecuador(the “Santa Elena Property”) totaling $1,429,332 and $1,570,020 as of September 30,2008 and December 31, 2007, respectively. The Company accounts for this investment under the cost method andrecords its share of cash received or paid as other income or expense.  Since the Company’s investment representsownership of an oil and gas property, which is a depleting asset, the Companyis amortizing the cost of the investment on a straight-line basis over theremaining term of the license agreement which expires in May 2016.  Accordingly, the Company recordedamortization expense of $46,896 and $140,688 for the three and nine monthsended September 30, 2008, respectively, as well as for the three and ninemonths ended September 30, 2007, respectively.

 

**Note 8 — Restricted Cash and PerformanceBonds**

 

As of September 30,2008, the Company had restricted cash deposits of $5.9 million, which partiallycollateralizes five performance bonds totaling $8.0 million in connection with its properties in Perucompared to restricted cash deposits of $2.8 million, which partiallycollateralized five performance bonds totaling $6.0 million and a currentrestricted cash deposit of $1.0 million related to a drilling servicecontract as of December 31, 2007. The Company obtained these performance bonds to insure certainobligations and commitments related to performance obligations under thelicense contracts for Blocks Z-1, XIX, XXII and XXIII as well as a performancecommitment under the drilling service contract.

 

During the nine months ended September 30, 2008, the Company wasrefunded $0.3 million related to the performance bond for the secondexploration phase under the Block XIX license contract and approximately $1.0million related to a performance commitment under a drilling servicescontract.  The Company posted a $0.6million performance bond that was required in connection with the third phaseof exploration under the Block XIX license contract.  The Company also posted a $2.8 million bondto guarantee import duties for the FPSO barge and transport tanker as well asthe BPZ-02.

 

All of the performance bonds are issued by Peruvian banks and theirterms are governed by the corresponding license contract.

 

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

** **

In February 2008,the Company entered into a lease-purchase agreement to acquire the deck bargeBPZ-02 to assist in the platform refurbishment and drilling activities in theAlbacora field as well as to assist in future offshore drilling and developmentactivities.  See Note 5 “Property, Equipment and Work in Progress”,included herein, for further discussion.  The terms of the lease-purchasestipulate a 19% rate of interest (33% effective rate of interest) over a one-yearterm ending February 2009 at which point, title to the BPZ-02 willtransfer to the Company upon final payment of the lease.  The Companyaccounted for the transaction as a Capital Lease in accordance to SFAS No. 13,“Accounting For Leases (As Amended)” under the applicable criteria, title tothe barge will transfer at the end of the lease period and, as a result,depreciation will be calculated over the economic life of the asset.  Lease payments are fixed at $694,167 permonth.  The capital lease asset wasrecorded at approximately $7.0 million, which represents the present value ofthe minimum lease 

 

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payments, or the fairmarket value of the asset.

 

The discovery ofoil reserves in the Corvina field prompted the Company to direct its attentiontowards accelerating the development of oil production in the Corvinafield.  Accordingly, on June 13,2007 the Company entered into a capital lease agreement, with an option topurchase, for two barges to assist in the development of the Corvina oil.  The capital lease for the two barges began inAugust 2007 and expires in November 2009.  The lease contains a purchase option whichthe Company anticipates, for accounting purposes, it will exercise on the 15thmonth of the lease term.  Lease paymentsare variable, based on the working status of the barges, with a purchase optionof $5,000,000 after the first year of the lease and $4,000,000 after thematurity date of the lease.  The capitallease obligation was recorded at the present value of the minimum leasepayments at an imputed discount rate of 18%, which reflects the Company’sincremental borrowing rate for this transaction.  The capital lease obligation was recorded atapproximately $6.2 million, which represents the present value of the minimumlease payments, or the fair market value of the debt obligation.

 

The FPSO, theNamoku, as well as the storage barge, the Nu’uanu, are under a separate capitallease agreement.  The capital lease forthe production equipment commenced in June 2008, the date the equipmentwas put into service.  The lease termsare variable and bear an interest rate of 18% based on the Company’sincremental borrowing rate for similar equipment.  In accordance with the terms of the lease, abargain purchase option exists at the end of the lease.  As a result, depreciation will be calculatedover the economic life of the asset.  TheCompany recorded the capital lease at $2.4 million, which represents thepresent value of the minimum lease payments at the Company’s incrementalborrowing rate over the term of the lease, or the fair market value of theasset.

 

Asof September 30, 2008 and December 31, 2007, the Company hadlong-term debt outstanding of $22,580 and $15,537,293, respectively.  The decrease in long-term debt and capitallease obligations outstanding is primarily related to convertible debt.  On November 19, 2007, a convertible debtagreement between IFC and the Company was entered into for approximately $15.5million.  The terms of the loan agreement stipulated a conversion price of$10.39 per share and included a forced conversion exercisable at the Company’soption if the closing price of the Company’s common stock exceeded a price of$18.19 per share, based on the average closing price over twenty consecutivebusiness days.  In May 2008, theCompany converted its long-term debt into 1,491,819 shares of BPZ common stock. The IFC currently ownsapproximately 10% of the Company’s outstanding common stock.

 

Long-termdebt and capital lease obligations as of September 30, 2008 and December 31,2007 also includes two secured loans for the purchase of office furniture.  Both loans have a term of 60 months, bearinginterest at 5.94% and 9.44%, respectively, with principal and interest paymentsdue on a monthly basis.

 

During the ninemonths ended September 30, 2008, the Company entered into two loanagreements with Peruvian banks to borrow approximately $2.8 million.  The loans were collateralized by IGVreceivables and bore interest rates of approximately 8% each.  The Company paid off the entire outstandingbalance as of September 30, 2008.

 

On August 18,2008, the Company, through its subsidiaries BPZ Exploracion &Produccion S.R.L and BPZ Marine Peru S.R.L as borrowers, entered into a $15.0million reserve-based lending facility (the “Loan Agreement”) with IFC.  The $15.0 million lending facility representsthe first tranche of an expected overall lending package of $215 million. Theproceeds will primarily be used to fund the GE Turbines purchase.  The reserve-based lending facility matures inDecember 2012 and bears interest at an approximate rate of LIBOR plus2.75%, currently equivalent to 5.85% based on the current six month LIBOR rateof 3.1%.  The maximum amount available under this facility will begin at$15.0 million and will be reduced by $2.5 million beginning on December 16,2010 and every six months thereafter during the term of the LoanAgreement.  The facility is subject to a semi-annual borrowing basedetermination based on the value of oil reserves.  In addition, theCompany is subject to various financial covenants calculated as of the last dayof each quarter, including a life of field coverage ratio, life of loancoverage ratio, debt to equity ratio and interest cover ratio. The Company wasin compliance with all applicable covenants of the Loan Agreement as of September 30,2008.  Funding for the initial $15.0million facility was subject to satisfying certain conditions precedent whichwere fulfilled on October 17, 2008 and the entire $15.0 million was drawndown.

 

TheLoan Agreement provides for events of default customary for agreements of thistype, 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 financing documents withthe IFC, the development and operation of the Corvina Field in Block Z-1, anyadditional petroleum assets under license contracts with Perupetro or certainother key agreements; revocation of any financing or security documents withthe IFC or certain key agreements; defaults on certain liabilities; certain 

 

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judgments against the borrower or anysubsidiary; abandonment or extended business interruption of the Corvina Fieldor certain other petroleum assets; engagement in certain sanctionablepractices; or restrictions are enacted in Peru that could inhibit any payment aborrower is required to make under the financing documents with the IFC.

 

Ifan event 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.

 

OnSeptember 4, 2008, Natixis, a major French bank, the co-facilityagent with IFC, obtained approval from its Credit Committee to arrange andunderwrite the second tranche of $200 million. This second tranche ofthe $215 million reserve-based lending facility is currently being negotiatedwith Natixis and is expected to close in fourth quarter 2008. The Company will draw down on the facilityonly when necessary.  Initial availablefunding of approximately $60 million is expected shortly thereafter subject tomeeting certain conditions precedent to funding.  The remaining $140 million will be madeavailable as the lending syndicate is identified, which is expected to occur inearly 2009.  The second tranche isexpected to be governed by generally the same default provisions describedabove.

 

Inaddition to the $215 million reserve-based lending facility previouslydescribed, the Company is also negotiating with IFC an additional facility inthe amount of $120 million which will be dedicated to the gas-to-power projectand is expected to close by mid 2009.  This additional facility will bestructured as traditional project financing and is expected to be for a term ofeight years and at a similar interest rate as the senior debt.

 

Maturities of debtand capital lease obligations as of September 30, 2008 are as follows:

 
| Less than one year   |   | $      | 10,178,548 |   |
|----------------------|--------|--------|------------|--------|
| One to three years   |   | 22,580 |       |
| Three to five years  |   | — |       |
| More than five years |   | — |       |
| Total                |   | $      | 10,201,128 |   |

 

**Note10 — Stockholders’ Equity**

 

The Company has 25,000,000 shares of preferred stock, no par value, and250,000,000 shares of common stock, no par value, authorized for issuance.

 

**Public Offering of Common Stock**

 

On March 25, 2008,the Company closed a public offering of 2.0 million shares of commonstock.  The offering was priced to thepublic at $20.00 per share and underwritten by Canaccord Adams, Inc. (“Canaccord”)on a firm commitment basis.  The Companyreceived proceeds after underwriting fees and discounts of approximately $37.5million.  In addition, the Companygranted Canaccord a 30-day option to purchase up to 200,000 additional sharesto cover any over-allotments.  On April 18,2008, the over-allotment option was executed and Canaccord bought an additional200,000 shares resulting in proceeds to the Company after underwriting fees anddiscounts of approximately $3.6 million. A financial advisory fee of $150,000 was paid to Morgan Keegan forinvestment services and consulting related to the offering.

 

The Company has used theproceeds from the offering for general corporate purposes, including: thereduction of outstanding indebtedness, or other corporate obligations, capitalexpenditures and general working capital requirements, including testing anddrilling operations and commencement of development of the Company’s AlbacoraField property.

 

**Potentially Dilutive Securities**

 

In addition to its shares issued and outstanding, the Company has the following potentially dilutive securities as of September 30, 2008 and December 31, 2007.  None of these potentially dilutive shares have been included in the calculation of earnings per share for the three and nine months ended September 30, 2007 nor for the nine months ended September 30, 2008, as the effect would be anti-dilutive.  However, due to positive earning for the three months ended September 30, 2008, 

 

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approximately 3,312,348 potentially dilutive shares were used in the calculation of diluted earnings per share as their exercise price was below the market price of the Company’s outstanding common stock as of the balance sheet date.

 

The potentially dilutive shares are as follows:

 

| ** **                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                          | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Stock options outstanding                                           |       | 3,856,848              |       | 4,175,448             |       |
| Warrants outstanding                                                |       | —                 |       | 250,000               |       |
| Shares issuable under IFC convertible debt  agreement               |       | —                 |       | 1,491,819             |       |
| Total potentially dilutive securities  issued                       |       | 3,856,848              |       | 5,917,267             |       |
| Shares available pursuant to Long-Term  Incentive Compensation Plan |       | 2,578,950              |       | 3,152,450             |       |

 

On January 1,2006, the Company adopted SFAS No. 123 — Revised 2004,*Share—BasedPayment* (“SFAS No. 123(R)”), which establishes accounting forstock-based payment transactions for employee services and goods and servicesreceived from non-employees.  SFAS No. 123(R) isa revision of SFAS No. 123, *Accounting for Stock-BasedCompensation*, and supersedes APB No. 25, *Accountingfor Stock Issued to Employees*. Under the provisions of SFAS No. 123(R), stock-based compensationcost is measured at the date of grant, based on the calculated fair value ofthe award, and is recognized as expense over the employee’s or non-employee’sservice period, which is generally the vesting period of the equity grant.

 

The Company adopted SFAS No. 123(R) using the modifiedprospective application method and, accordingly, no prior periods have beenrestated as a result of the adoption of this pronouncement.  Under this method, compensation costrecognized during the year ended December 31, 2006 included: (a) compensationcost for all stock-based payments granted prior to, but not yet vested as of January 1,2006, based on the grant-date fair value estimated in accordance with theoriginal provisions of SFAS No. 123; and (b) compensation cost forall stock-based payments granted on or after January 1, 2006, based on thegrant-date fair value estimated in accordance with SFAS No. 123(R).  SFAS No. 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods to reflect actual forfeitures.

 

The following table summarizes stock-based compensation costsrecognized under SFAS 123(R) for the three and nine months ended September 30,2008 and September 30, 2007, respectively, and is included in general andadministrative expenses on the consolidated operating statement:

 

| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                   | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Employee stock—based compensation costs |       | $                                | 4,959,553  |                            | $          | 2,811,352 |   | $ | 13,419,317 |   | $ | 4,718,765 |   |
| Non-employee stock-based compensation        |       | —                           |       | —                          |       | — |   | (5,891 | ) |
|                                         |       | $                                | 4,959,553  |                            | $          | 2,811,352 |   | $ | 13,419,317 |   | $ | 4,712,874 |   |

 

See below for a detailed discussion regarding the Company’s employeelong-term incentive compensation plan and stock-based payments tonon-employees.

 

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**Restricted Stock Awards and PerformanceShares**

 

The Company determines the fair value of restricted stock awards andperformance shares based on the market price of the Company’s common stock onthe date of grant.  Compensation cost forsuch awards is recognized ratably over the vesting or service period, net offorfeitures; however, compensation cost related to performance shares will notbe recorded or will be reversed if the Company does not believe it is probablethat such performance criteria will be met or if the service provider (employeeor otherwise) fails to meet such criteria.

 

A summary of the Company’s restricted stock award activity and relatedinformation is presented below:

 
| ** **                                     | ** ** | ** **         | ** ** | **Weighted—**  | ** ** |
|------------------------------------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                     | ** ** | **Number of** | ** ** | **Average**         | ** ** |
| ** **                                     | ** ** | **Restricted**     | ** ** | **Fair Value** | ** ** |
| ** **                                     | ** ** | **Shares**         | ** ** | **Per Share**  | ** ** |
| Non-vested balance at December 31,  2007  |       | 1,284,850          |       | $                   | 8.82       |   |
| Granted                                        |       | —             |       | $                   | —     |   |
| Vested                                         |       | (245,000           | )          | $                   | 4.15       |   |
| Forfeited                                      |       | (11,000            | )          | $                   | 4.10       |   |
| Non-vested balance at September 30,  2008 |       | 1,028,850          |       | $                   | 9.98       |   |

 

As of September 30, 2008, there was approximately $7.2 million oftotal unrecognized compensation cost related to non-vested restricted stockawards, which is expected to be recognized over a weighted-average period ofapproximately 1.29 years.

 

**Stock Options**

 

Incentive and non-qualified stock optionsissued to directors, officers, employees and consultants are issued at anexercise price equal to the fair market value of the stock at the date ofgrant.  The majority of the Company’sstock options vest pro-rata over three years from the grant date and generallyexpire ten years from the date of grant. Compensation cost related to stock options is recognized on astraight-line basis over the vesting or service period and is net offorfeitures.

 

The fair value of each stock option grantedis estimated on the date of grant using a Black-Scholes option pricingmodel.  The following table presents theweighted-average assumptions used in the option pricing model for options grantedduring the nine months ended September 30, 2008.  During the nine months ended September 30,2008, 594,500 options were granted by the Company under the 2007 Long-TermIncentive Plan.  The expected life of theoptions represents the period of time the options are expected to be outstanding.  For the nine months ended September 30,2008, the expected term was derived using the facts and circumstances relevantto the Company, from the analysis of other companies of a similar size andoperational life cycle as well as the limited Company history of stockexercises.  For the nine months ended September 30,2007, the expected term of options granted was derived based on a weightingbetween (a) the Company’s historical exercise and forfeiture activity and (b) theaverage midpoint between vesting and the contractual term.  For the nine months ended September 30,2008 and September 30, 2007, our expected volatility is based on thehistorical volatility of our stock for a period approximating the expectedlife.  The risk-free interest rate isbased on the observed U.S.  Treasuryyield curve in effect at the time the options were granted.  The dividend yield is based on the fact theCompany does not anticipate paying any dividends.

 
| ** **                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Expected life (years)                                |       | 4.48     |       | 6        |       |
| Risk-free interest rate                              |       | 3.5      | %          | 4.4      | %          |
| Volatility                                           |       | 79.93    | %          | 83.76    | %          |
| Dividend yield                                       |       | 0        | %          | 0        | %          |
| Weighted-average fair value per share at  grant date |       | $        | 15.99      |     | $          | 3.84 |   |
|                                                      |            |          |            |          |            |  |  |

 

A summary of our stock option activity and related information ispresented below:

 

During the nine months ended September 30, 2008 a total of 903,100options were exercised.  As of September 30,2008, there was approximately $13.9 million of total unrecognized compensationcost related to non-vested stock options which is expected to be recognizedover a weighted-average period of approximately 1.48 years.

 

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The following tables summarize information about stock optionsoutstanding as of September 30, 2008:

 
| ** **                                  | ** ** | ** **  | ** ** | **Outstanding**     | ** ** | **Exercisable**         | ** ** |
|---------------------------------------------|------------|-------------|------------|---------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | ** **  | ** ** | ** **          | ** ** | **Weighted-**           | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **  | ** ** | ** **          | ** ** | **Average**             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **  | ** ** | ** **          | ** ** | **Remaining**           | ** ** | ** ** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                  | ** ** | ** **  | ** ** | ** **          | ** ** | **Contractual**         | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | ** **  | ** ** | **Number of**  | ** ** | **Life**                | ** ** | **Weighted** | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| **Range of Exercise Prices** | ** ** | **Options** | ** ** | **(In years)** | ** ** | **Exercise Price** | ** ** | **Options** | ** ** | **Per Option** | ** ** |
| Below                                       |       | to          | $2.12      |                | 99,248     |                    | 5.7        |   | $ | 1.30 |   | 99,248 |   | $ | 1.30 |   |
| $2.13                                       |       | to          | $4.23      |                | 950,000    |                    | 7.4        |   | $ | 3.41 |   | 895,000 |   | $ | 3.36 |   |
| $4.24                                       |       | to          | $6.35      |                | 611,000    |                    | 8.5        |   | $ | 4.94 |   | 258,169 |   | $ | 4.92 |   |
| $6.36                                       |       | to          | $8.47      |                | 120,900    |                    | 8.3        |   | $ | 6.50 |   | 35,905 |   | $ | 6.50 |   |
| $8.48                                       |       | to          | $10.58     |                | 211,200    |                    | 8.8        |   | $ | 10.43 |   | — |   | $ | — |   |
| $10.59                                      |       | to          | $25.53     |                | 1,864,500  |                    | 8.6        |   | $ | 15.76 |   | — |   | $ | — |   |
| Total                                       |       |        |       |                | 3,856,848  |                    | 8.2        |   | $ | 10.05 |   | 1,288,322 |   | $ | 3.60 |   |
|                                             |            |             |            |                     |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                 | ** ** | ** **         | ** ** | **Weighted—**      | ** ** |
|------------------------------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | ** **         | ** ** | **Average**             | ** ** |
| ** **                                                 | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| ** **                                                 | ** ** | **Options**        | ** ** | **Per Option**     | ** ** |
| Options outstanding at December 31,  2007             |       | 4,175,448          |       | $                       | 8.14       |   |
| Granted                                                    |       | 594,500            |       | $                       | 23.60      |   |
| Exercised                                                  |       | (903,100           | )          | $                       | 2.73       |   |
| Forfeited                                                  |       | (10,000            | )          | $                       | 4.23       |   |
| Options outstanding at September 30,  2008            |       | 3,856,848          |       | $                       | 10.05      |   |
|                                                       |       |               |       |                    |       |   |
| Options vested and exercisable at  September 30, 2008 |       | 1,288,322          |       | $                       | 3.60       |   |

 

The aggregate intrinsic value of stockoptions outstanding at September 30, 2008 was approximately $31.9 million,of which approximately $17.5 million relates to awards vested and exercisableand approximately $14.4 million relates to awards expected to vest.  The intrinsic value for stock optionsoutstanding is calculated as the amount by which the quoted price of our commonstock as of September 30, 2008 exceeds the exercise price of the option.

 

**Warrants**

 

No warrants were granted during the ninemonths ended September 30, 2008 or September 30, 2007.  As of September 30, 2008, the Companyhad no warrants outstanding.

 

For their role as placement agent, inconnection with the private placement of 11,466,000 shares of common stock in July 2005,Morgan Keegan & Company, Inc. received fully vested warrants topurchase 100,000 shares of the Company’s common stock at an exercise price of$3.00 per share.  These warrants were setto expire on July 19, 2010 and were valued at $325,000 using the Black-Scholesmodel, which amount was treated as additional non-cash stock offering costs.Additionally, for their financial advisory services, in connection with theprivate placement of 4,482,000 shares of common stock in June 2006, MorganKeegan & Company, Inc. received fully vested warrants to purchase150,000 shares of the Company’s common stock at an exercise price of $3.00 pershare.  These warrants were set to expireon June 30, 2011 and were valued at $248,645 using the Black-Scholesmodel, which amount was treated as additional non-cash stock offeringcosts.  During the nine months ended September 30,2008, Morgan Keegan exercised warrants to purchase 250,000 shares of theCompany’s common stock at an exercise price of $3.00.  As a result, the Company received proceeds of$750,000.

 

**Note11**—**Revenue**

 

The Companybegan producing oil on a limited basis in November 2007 from the CX11-21XDand 14D wells in the Corvina Field under an extended well testing program.  During the second quarter 2008, it addedproduction from the 18XD well under the extended well testing program.  The oil is delivered by barge to thePetroperu refinery in Talara, located 

 

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approximately 100 miles southof the platform.  The remainder is keptin production inventory until the Company increases the inventory quantities toa sufficient level that the refinery in Talara will accept delivery.  The Company has entered into two contractsfor the sale of oil to Petroperu since it began oil production in November 2007.  The first contract was for the sale of up to200,000 barrels of oil to the refinery in Talara.  The contract was fulfilled in June 2008.  The current sales contract with Petroperu isfor the deliver of up to 400,000 barrels of oil to the Talara refinery.  Similar to the first sales contract, thecurrent sales contract is based on Northwest Oil Basket pricing which iscomprised of Oman, Fortes and Suez Blend pricing.  The unadjusted sales price is based on thepast five day average before the crude oil delivery date.  The price is then discounted for the qualityof the oil delivered.  The determinationof quality is based on the gravity of the oil expressed in degrees, asdetermined under standards established by the American Petroleum Institute (“API”).  The price is discounted at a rate of 0.53% ofthe basket price per one degree API lower than the benchmark of 33 degrees APIas stipulated in the contract.  Inaddition, a fixed premium of $0.75 per barrel is added to the price as a resultof the high diesel content of the crude oil.

 

Royalties are calculated byPerupetro as stipulated in the Block Z-1 license agreement, based on the sameNorthwest Oil Basket.  However, theircalculation is based on the past two week average price before the crude oildelivery date, as opposed to being based on the past five day average beforethe crude oil delivery date.

 

The Corvina wells were voluntarilyshut-in as a result of the barge incident on January 30, 2008.  Production resumed in full on June 9,2008, as a result of the Company receiving the clearance needed to transportoil from the CX-11 platform to the nearby Talara refinery by the correspondingPeruvian environmental agency.  Inaddition, its FPSO vessel was placed in position near the CX-11 platform andbegan receiving production from the platform during the second quarter ended June 30,2008.

 

During the three and ninemonths period ended September 30, 2008, the Company produced approximately329,090 barrels and 455,841 barrels, respectively.  It sold approximately 322,171 barrels and437,243 barrels during the three and nine months ended September 30, 2008at an average price, net of royalties, of approximately $103.80 per barrel and$102.56, respectively.  In January 2008,BPZ incurred production and transportation delays due to the incident involvingone of the Peruvian Navy tankers being used to transport oil to market. SeeNote 1, “Basis of Presentation and Significant Accounting Policies — Corvina”above for a more detailed discussion of the incident. ** **Approximately 1,300 barrels of oil were lost in the fire aboard thetanker.  The cost of the crude oil lostwas approximately $62,000 and was expensed through lease operating expense anddepreciation, depletion and amortization.

 

The Company had no oil salesduring the three and nine months ended September 30, 2007.

 

**Note 12 — Foreign Currency**

** **

The U.S. Dollar is the functional currency for our operations in bothPeru and Ecuador.  Ecuador has adoptedthe U.S. Dollar as its official currency. Peru, however, uses its local currency, Nuevo Soles, in addition to theU.S. Dollar, and therefore, our financial results are subject to favorable orunfavorable fluctuations in the exchange rate and inflation of thatcountry.  Transaction differences havebeen nominal to date but are expected to increase as our activities in Perucontinue to escalate.  During the threeand nine months ended September 30, 2008, we incurred an exchange rateloss of approximately $58,147 and an exchange rate gain of approximately$165,637, respectively.  The exchangerate gain is primarily related to the early recovery of IGV or Value AddedTaxes in Peru.  IGV under the earlyrecovery program is denominated in the Peruvian Nuevo Sol currency.  However, the total gain during the ninemonths ended September 30, 2008 was partially offset in the third quarterby Nuevo Sol denominated accounts payable being settled during thequarter.  A net foreign currency gain wasrealized due to the strengthening of the Nuevo Sol against the US Dollar.

 

**Note 13 — Income Tax**

** **

***As of September 30,2008, t***heCompany had a valuation allowance for the full amount of the domestic deferredtax asset resulting from the income tax benefit generated from net losses, asit believes, based on the weight of available evidence, that it is more likelythan not that the deferred tax asset will not be realized prior to theexpiration of net operating loss carryforwards in various amounts through2027.  However, the Company is subject toPeruvian income tax on its earnings at a statutory rate, as defined in theBlock Z-1 License Contract, of 22%. Because the Company is under an extended well testing program from whichit will finalize a development plan for Block Z-1, it has not moved into thecommercial phase of production as defined by the license contract.  As such, certain deductions are disallowed bythe Peruvian tax regime while the Company operates under the extended welltesting program.  In addition, the taxprovision is based on taxable Peruvian income that excludes certain U.S.expenses that are not deductible at the Peruvian level. As a 

 

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***result, the Company recognized a total tax provision for thethree and nine months ended September 30, 2008 of approximately $5,050,821and $5,291,401, respectively.***

*** ***

Estimatedinterest and penalties related to potential underpayment on unrecognized taxbenefits, if any, are classified as a component of tax expense in theConsolidated Statement of Operations. As of the date of adoption of FIN 48, theCompany did not have any accrued interest or penalties associated with anyunrecognized tax benefits, nor was any interest expense recognized during thequarter.

 

**Note 14 — Affiliate and Related Party Transactions**

** **

As of September 30, 2008 and December 31, 2007,the Company had no outstanding balances with affiliates or related parties.

 

**Note 15 — Commitments and Contingencies**

 

*Charter of Navy Tankers*

* *

On October 24, 2007, the Company’sformer primary marine transportation contractor entered into two short termagreements with the commercial division of the Peruvian Navy to lease twotankers to transport oil to market.  On January 30,2008, one of the tankers, the Supe, sank after catching fire.  At the time of the incident, the tankercontained approximately 1,300 barrels of oil. No Company employees wereinjured. Official environmental impact assessments concluded that environmentalissues have been adequately controlled. Even though no civil claims havebeen asserted against the Company as a result of the Supe incident, the Companybelieves that it, as a contracting party, and its third party marinecontractor, as the time charterer of the Supe, may have limited exposure tocivil liability resulting from the Supe incident.  However, the Companyconsiders any such liability to be remote and that such limited exposure, whileunknown at this time, will not have a material effect on its financialstatements.

 

*Barge Incident*

 

In early August 2006, the Companyincurred an operational delay resulting from a navigation incident which causedthe BPZ-01 barge to be grounded on a sand bank in Talara Bay in northwestPeru.  As of September 30, 2008, theCompany recorded approximately $612,000 in insurance receivable pending thesubmission of an insurance claim estimated to be approximately $712,000.  A deductible of $75,000 will be applied to this insuranceclaim when reimbursed.

 

The Company received proceeds from itsunderwriter to cover a related claim regarding third party cargo that had beendamaged in the grounding incident mentioned above.  During the three months ended September 30,2008, approximately $80,000 of insurance proceeds were received in connectionwith this claim.  A deductible of $25,000was offset against the insurance proceeds received.  This amount is unrelated to the $712,000 hullclaim described above as the proceeds from the cargo claim was to the thirdparty owner of the cargo that was damaged. The hull claim will be finalized upon the dry docking of the vessel.  Because of the delays caused by the drillingof the highly deviated CX11-20XD well during the third quarter 2008, the drydock of the BPZ-01 is scheduled during the first quarter of 2009.  As of November 9, 2008, the Company hasnot presented a final claim to its insurance carrier for the barge repairs.

 

The Company believes that the majority of thecosts associated with the grounding incident will be reimbursed throughinsurance or through a third party.  Noassurances can be given, however, that any such recoveries will be sufficientto cover all costs associated with the incident or to the timing of any suchrecoveries.  The Company intends to filean insurance claim with our underwriters by the end of the first quarter 2009as well as finalize the reimbursement agreement with the third party.

 

As a result of the delayed dry dock of theBPZ-01, the Company allowed the Certificate of Inspection from the U.S. CoastGuard to expire, thus prohibiting the BPZ-01 from transporting hazardous cargowithin U.S. federal waters.  Because theCompany does not intend to take the BPZ-01 out of Peruvian waters, it hasre-flagged the BPZ-01 and it is no longer subject to U.S. jurisdiction.

 

*PeruProperties*

 

Inconnection with its properties in Peru, the Company has obtained fiveperformance bonds totaling $8.0 million to insure certain obligations andcommitments, of which one related to the guarantee of import duties related tothe FPSO and transport tanker and four relate to performance obligations underthe license contracts for Blocks Z-1, XIX, XXII and XXIII.  

 

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As of September 30, 2008, the Company had restricted cash depositsof $5.9 million, which partially collateralizes the performance bonds describedabove.  See Note 8 “Restricted Cashand Performance Bonds” included herein, for further discussion.

 

*Capital Lease of Barge and FPSO Equipment*

 

In February 2008, the Company entered into a lease-purchaseagreement to acquire a deck barge (“BPZ-02”) to assist in the platformrefurbishment and drilling activities in the Albacora field as well as toassist in future offshore drilling and development activities.  In thenear term, the BPZ-02 will be used to act as a tender assist for the Petrexdrilling rig as it is moved to the Albacora field in first quarter 2009. During that time, the BPZ-01 will be placed in dry-dock to repair damagessustained when it ran aground in late 2006.  The acquisition of the BPZ-02allows the Company better asset maintenance scheduling and will aid in thesupport of increased offshore exploration and development activities.  Theterms of the lease-purchase stipulate a 19% rate of interest (33% effectiverate of interest) over a one-year term at which point, title to the BPZ-02 willtransfer to the Company upon final payment of the lease.  The Company hasaccounted for the transaction as a capital lease in accordance to SFAS No. 13,“Accounting For Leases (As Amended)” under the criteria the barge will transfertitle at the end of the lease period and, as a result, depreciation will becalculated over the economic life of the asset.

 

The FPSO equipmentwas financed through a separate capital lease that commenced when the Companybegan utilizing the production equipment on board the FPSO in June 2008.  The lease terms are variable and bear aninterest rate of 18% based on our incremental borrowing rate for similarequipment.  In accordance with the termsof the lease, a bargain purchase option exists at the end of the lease.  As a result, depreciation will be calculatedover the economic life of the asset.  TheCompany recorded the capital lease at $2.4 million, which represents thepresent value of the minimum lease payments at the Company’s incremental borrowingrate over the term of the lease, or the fair market value of the asset.

 

See Note 5 “Property,Equipment and Construction in Progress” included here in, for furtherdiscussion of both leases referred to above.

 

*Equipment Purchase Agreement*

 

OnSeptember 26, 2008, the Company, through its subsidiary Empresa EléctricaNueva Esperanza, SRL(the “Subsidiary”), entered into a $51.5 million contractfor purchase of equipment and services (the “Agreement”) with GE Packaged Power, Inc.and GE International, Inc. Sucursal de Peru, which are part of GE Energy’saeroderivative business.  The Agreement obligates the Company to purchasethree LM6000 gas-fired turbines, with an option to purchase a fourth unit, andrequired an initial down payment of $5.1 million.  Monthly progresspayments of $1.1 million will commence in October 2008 for the first unit,$2.3 million in November 2008 for both the first and second units, $3.4million in December 2008 through September of 2009 for all threeunits, $2.3 million in October of 2009 for two units and $1.1 million in November of2009 for the final unit.  A final payment of $1.7 million per unit ($5.1million total) is due five days after the issuance of the seller’s Notice ofReadiness to Ship for each unit.  The contract also contains anoption to purchase one additional unit for $18.2 million.  Each turbinewill have a generation capacity of 45 megawatts, with excess capacity ofapproximately 5%.  Delivery of the three units is scheduled for the fourthquarter 2009.

 

Inaddition, should the Subsidiary fail to timely make progress payments on theturbines due by December 15, 2008, or fail to provide a comfort letterfrom the facility agents by December 15, 2008 as required by theAgreement, then the Company will be required to provide a corporate guaranty ofthe Subsidiary’s remaining payments on or before December 18, 2008. The corporate guaranty is conditioned upon the Company meeting a financial testof earnings before interest, taxes, depreciation, amortization, and exploratoryexpenses (not to exceed $5 million) for the three month period ending October 31,2008 equal to or greater than 2.25 times the sum of payments due for the periodbetween January and March of 2009. If the financial test is not met,the Subsidiary will be required to provide a standby letter of credit. The Subsidiary may replace the standby letter of credit with the Company’scorporate guaranty if the Company later meets the financial test for anysubsequent three month period.

 

Initially, the Company expects that funding of payments due under theAgreement will come from an on-lending arrangement contained in the $215million reserve-based lending facility. After the $120 million project financing mentioned in Note 9 above isclosed and funded as expected, any amounts borrowed under the $215 millionreserve-based lending

 

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facility will be repaid fromthose proceeds.  For a more detaileddescription of the $215 million reserve-based lending facility, see Note 9, “Long-TermDebt and Capital Lease Obligations”.

 

*Financing Activities*

 

The Company is actively negotiating with IFCto increase the total debt package to an estimated $350 million for furtherdevelopment of its assets, of which $120 million of the total financing packagewas approved by the Credit Committee of the IFC on November 29,2006 and $200 million was approved by the Natixis Credit Committee on September 4,2008.  See Note 14 “Commitments andContingencies – *Financing Activities”* in theNotes to the Consolidated Financial Statements included in the Company’s Form 10-K,as amended, for the year ended December 31, 2007 for furtherdiscussion.  Part of the debtissuance was funded through a “C” Loan, which was comprised of $15.5 million ofconvertible debt and was closed in early November 2007.  The terms of the “C” Loan agreement stipulatea conversion price of $10.39 per share and include a forced conversionexercisable at the Company’s option if the average closing price of the Company’scommon stock exceeds a price of $18.19 per share based on the average closingprice over twenty consecutive business days. The Company exercised its conversion option during the second quarter2008.  This brought IFC’s total ownershipin the Company’s common stock to approximately 10%.  The Company anticipates the remaining debtissuance balance to be funded through the following two facilities:

 

·                                       On August 18,2008, the Company, through its subsidiaries BPZ Exploracion &Produccion S.R.L and BPZ Marine Peru S.R.L as borrowers, entered into a $15.0million reserve-based lending facility (the “Loan Agreement”) with theIFC.  The $15.0 million lending facilityrepresents the first tranche of an expected overall lending package of $215million.  The proceeds will primarily beused to fund the GE Turbines purchase. The reserve-based lending facility matures in December 2012 andbears interest at an approximate rate of LIBOR plus 2.75%, currently equivalentto 5.85% based on the current six month LIBOR rate of 3.1%.  The maximumamount available under this facility will begin at $15.0 million and will bereduced by $2.5 million beginning on December 16, 2010 and every sixmonths thereafter during the term of the Loan Agreement.  The facility issubject to a semi-annual borrowing base determination based on the value of oilreserves.  In addition, the Company is subject to various financialcovenants calculated as of the last day of each quarter, including a life offield coverage ratio, life of loan coverage ratio, debt to equity ratio andinterest cover ratio. The Company was in compliance with all applicablecovenants of the Loan Agreement as of September 30, 2008.  Funding for the initial $15.0 millionfacility was subject to satisfying certain conditions precedent which werefulfilled on October 17, 2008 and the entire $15.0 million was drawn down.

 

On September 4, 2008, Natixis, a major French bank, theco-facility agent with IFC, obtained approval from its Credit Committee toarrange and underwrite the second tranche of $200 million.  This second tranche of the $215 millionreserve-based lending facility is currently being negotiated with Natixis andis expected to close in fourth quarter 2008. The Company will draw down on thefacility only when necessary.  Initialavailable funding of approximately $60 million is expected shortly thereaftersubject to meeting certain conditions precedent to funding.  The remaining $140 million will be madeavailable as the lending syndicate is identified, which is expected to occur inearly 2009.

 

·                                        The Company isnegotiating an additional $120 million debt facility to fund the development ofits gas-to-power project.  The finalamount will be a function of the type of generation equipment ultimatelyselected.  The Company is currentlynegotiating the engineering, procurement and construction contracts that willbe conditions precedent to this credit facility.  The Company anticipates closing this loan bymid 2009.

 

As of November 7, 2008, the final loan documents for the $200million and $120 million loans have not been completed and are subject to finalnegotiations, documentation and satisfaction of certain conditions.  See Note 9, “Long-Term Debt and Capital LeaseObligations” for further detail regarding the IFC and Natixis lendingfacilities.

 

**Note 16 — Legal Proceedings**

 

See Note 15 “Legal Proceedings” in the Company’sConsolidated Financial Statements included in its Form 10-K, as amended,for the year ended December 31, 2007, for detailed discussion.

 

In addition, on October 24, 2007, theCompany’s former primary marine transportation contractor entered into twoshort-term agreements with the commercial division of the Peruvian Navy tolease two tankers to transport oil to market. On 

 

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January 30, 2008, one of the tankers, the Supe, sankafter catching fire.  At the time of theincident, the tanker contained approximately 1,300 barrels of oil. No Companyemployees were injured. Official environmental impact assessments concludedthat environmental issues have been adequately controlled. Even thoughno civil claims have been asserted against the Company as a result of the Supeincident, the Company believes that it, as a contracting party, and its thirdparty marine contractor, as the time charterer of the Supe, may have limitedexposure to civil liability resulting from the Supe incident.  However,the Company considers any such liability to be remote and that such limitedexposure, while unknown at this time, will not have a material effect on itsfinancial statements.

 

**Note 17 — Subsequent Event**

 

On October 17,2008, the Company satisfied certain conditions precedent to funding the initialtranche of the $215 million IFC and Natixis reserve-based lending facility.  As a result, the Company received $15.0million in proceeds.  See Note 9 “Long-TermDebt and Capital Lease Obligations”for further detail.

 

**Item 2. Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Overview**

 

You should read the following discussion andanalysis together with our consolidated financial statements and notes theretoand the discussion Item 7. “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” Item 7A, “Quantitative and QualitativeDisclosures About Market Risk” and Item 1A.  “Risk Factors” includedin our Annual Report on Form 10-K, as amended, for the yearended December 31, 2007.  Thefollowing information contains forward-looking statements that involve risks,uncertainties and assumptions.  Shouldone or more of these risks or uncertainties materialize, our actual results maydiffer from those expressed or implied by the forward-looking statements.  See “Disclosure Regarding Forward-LookingStatements” below.

 

BPZ Resources, Inc., a Texas corporation(the “Company” or “BPZ”), is based in Houston, Texas with offices in Lima, Peruand Quito, Ecuador.  We are focused onthe exploration, development and production of oil and natural gas in Peru andEcuador.  We also intend to utilize partof our future natural gas production as a supply source for our complementarydevelopment of a Company owned gas-fired power generation facility.

 

We maintain a Peruvian subsidiary through our wholly-ownedsubsidiary BPZ Energy, Inc., a Texas corporation (“BPZ — Texas”).  Currently, we have exclusive rights and licenseagreements for oil and gas exploration and production covering a total ofapproximately 2.4 million acres, in four blocks, in northwest Peru.  The license contracts cover 100% ownership ofBlock Z-1 (739,205 acres), Block XIX (472,860 acres), Block XXII (948,000acres) and Block XXIII (248,000 acres). The Block Z-1 contract was signed in November 2001, the Block XIXcontract was signed in December 2003 and Blocks XXII and XXIII contractswere both signed in November 2007.  Our license contracts provide foran initial exploration period of seven to thirteen years for Block Z-1 andseven to ten years for Blocks XIX, XXII and XXIII.  In addition, thecontracts require that we conduct specified activities on the properties duringthis period.  If the explorationactivities are successful, the total contract term can extend up to 30 yearsfor oil exploration and production and up to 40 years for gas exploration andproduction.

 

In addition, through our wholly-ownedsubsidiary, SMC Ecuador Inc., a Delaware corporation, and its registeredbranch in Ecuador, it owns a 10% non-operated working interest in an oil andgas 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 initial stages of developing andproducing our oil and natural gas reserves.  To date, our activities inPeru have been primarily limited to analysis and evaluation of technical dataon our properties, preparation of the development plans for the properties,including detailed engineering and design of the power plant and gas processingfacilities, refurbishment of two of our offshore platforms, procuring machineryand equipment for an extended drilling campaign, obtaining all necessaryenvironmental and operating permits, bringing production on-line and securingthe required capital and financing to conduct the current plan of operation.

 

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**OilDevelopment**

 

***CorvinaField***

 

We started producing oil from our recent discoveries at the CX-11platform, located in the Corvina Field in its offshore Block Z-1, under anextended well testing program which began on November 1, 2007.  TheCorvina field consists of 47,000 acres in water depths of less than 200feet.  We are currently concentrating ourdrilling efforts on West Corvina, which consists of 3,500 acres and we havecompleted a total of three oil producing wells, the CX11-21XD, the CX11-18XDand the CX11-14D.  The oil is deliveredby barge to the Petroperu refinery in Talara, located approximately 100 milessouth of the platform.  The remainder is kept in production inventory untilsuch time it is delivered to the refinery.

 

On October 24, 2007,our former primary marine transportation contractor entered into two short-termagreements with the commercial division of the Peruvian Navy to lease twotankers to transport oil to market.  On January 30,2008, one of the tankers, the Supe, sank after catching fire.  At the time of the incident, the tankercontained approximately 1,300 barrels of oil, most of which burned in the fire.No Company employees were injured. Official environmental impact assessmentsconcluded that environmental issues have been adequately controlled. Eventhough no civil claims have been asserted against us as a result of the Supeincident, we believe that we, as a contracting party, and our third partymarine contractor, as the time charterer of the Supe, may have limited exposureto civil liability resulting from the Supe incident.  However, we considerany such liability to be remote and that such limited exposure, while unknownat this time, will not have a material effect on our financial statements.  Consequently, the contract with thecommercial branch of the Peruvian Navy was allowed to expire in March 2008.  We have not entered into any new contractswith the Peruvian Navy.  As a result ofthe incident, our operations were voluntarily suspended at the CX-11 platform.

 

On March 14, 2008, we were notified by the OrganismoSupervisor de la Inversión en Energía y Mineria (“OSINERGMIN”), the government regulatoryagency in Peru responsible for monitoring industrial safety, that we couldresume drilling and testing operations at the CX-11 platform and as a result,we began testing the CX11-18XD well. Three drill stem tests were conducted in the Upper Zorritos formation.  The first two drill stem tests targeted thelower sands in zones that had not previously been tested.  The third drill stem test targeted sands thathad tested oil in our CX11-21XD well. We began producing from the 18XD well in May 2008and, on June 9, 2008, we received the clearance needed to transport oilfrom the CX-11 platform to the nearby Talara refinery by the correspondingPeruvian environmental agency.  Inaddition, our floating production storage and offloading (“FPSO”) vessel wasplaced in position near the CX-11 platform and is currently receivingproduction from the platform.

 

Upon completion of the CX11-18XD well referred to above, wespudded the CX11-20XD well in May 2008. The CX11-20XD well is positioned higher up the geologic structure fromthe CX11-21XD well.  The well has been positionedto further develop the top gas sands found in the previously drilled 21XD well,the oil sands currently producing in the 21XD and 18XD wells, the oil sandsencountered and briefly tested in the 18XD well during the initial drill-stemtest number one, as well as sands found in the 14D well.  Thewell tested positive for oil in quantities that we believe to be commerciallyproducible.  We completed two drill stemtests on four sets of oil sands in the well. Currently, we intend to complete the CX11-20XD well as an oil-producingwell under the extended well testing program currently ongoing at the Corvinafield. However, because the well crosses sands which tested positive for whatwe believe to be economic quantities of gas in both the 21XD and 18XD wells, weintend to re-complete the CX11-20XD well to allow the well to produce both gasand oil when the gas is needed for our gas-to-power project.

 

We intend to spud the CX11-15D well by mid-November 2008.  We expect this well to take approximately 90days to reach total depth, and to be tested and completed in early 2009.  The 15D well represents the final well to bedrilled from the CX-11 platform under the initial Corvina drilling program.  Upon completion of the CX11-15D well, weintend to focus our drilling efforts on the Albacora Field.

 

***Albacora Field***

 

The Albacora Field is located in the northern part of our offshoreBlock Z-1.  It consists of approximately6,000 acres and, like the Corvina Field, Albacora is located in water depths ofless than 200 feet. Once the drilling rig has been moved from Corvina and setin place the Albacora A-1 platform which is currently being refurbished, weplan to drill the A-14XD well, a twin well to Albacora’s discovery well to theAlbacora 8-X-2 discovery well.  The firstwell in Albacora will qualify will qualify as an exploratory well as we plan ontesting the prospective Lower Zorritos formation sands.  The 8-X-2 discovery well, drilled 35 yearsago, tested oil and gas in the upper Zorritos formation sands at quantities webelieve to be commercially producible. Our initial drilling plans in Albacora are to drill at least six newwells and then recomplete three oil wells currently shut-in at the A-1platform.

 

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**Gas-to-PowerProject**

 

The Corvina Gas-to-Powerproject entails the installation of a 10-mile gas pipeline from the CX-11platform to shore, construction of gas processing facilities and anapproximately 135 megawatt (“MW”) simple-cycle electric generating plant.  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 360 MW of power.In order to support our proposed electric generation project, we commissionedan independent power market analysis for the region. The Peruvian electricitymarket is deregulated and power is transported through an interconnectednational grid managed by the Committee for Economic Dispatching of Electricity(known as COES). Based on this study, we believe we will be able to selleconomic quantities of electricity from the initial 135 MW power plant. Themarket study also indicates that there may be future opportunities for us togenerate and sell significantly greater volumes of power into the Peruvian andpossibly Ecuadorian power markets.  Ourplan is to own 100% of the power plant. Accordingly, our revenues from thenatural gas delivered to the power plant will be derived from the sale ofelectricity, which is currently projected to commence mid 2010, though thisschedule is subject to many factors outside our control, including obtainingall necessary financing and equipment. No assurance can be given that we can meet this schedule.

 

We are currently workingon securing and finalizing funding for our gas to power initiatives comprisedof approximately $120 million of senior debt to be syndicated by theInternational Finance Committee (“IFC”), which is expected to close by mid2009. This financing will be subject to identification of the lending syndicatemembers and subsequent negotiation and approval of the necessary loandocumentation.

 

OnSeptember 26, 2008, we entered into a $51.5 million contract, through itssubsidiary Empresa Eléctrica Nueva Esperanza, SRL, for purchase of equipmentand services (the “Agreement”) with GE Packaged Power, Inc. and GEInternational, Inc. Sucursal de Peru, which are part of GE Energy’saeroderivative business.  The Agreement obligates us to purchase threeLM6000 gas-fired turbines, with an option to purchase a fourth unit, andrequired an initial down payment of $5.1 million. Monthly progresspayments of $1.1 million will commence in October 2008 for the first unit,$2.3 million in November 2008 for both the first and second units, $3.4million in December 2008 through September of 2009 for all threeunits, $2.3 million in October of 2009 for two units and $1.1 million in November of2009 for the final unit.  A final payment of $1.7 million per unit ($5.1million total) is due five days after the issuance of the seller’s Notice ofReadiness to Ship for each unit. The contract also contains an option topurchase one additional unit for $18.2 million.  Each turbine will have ageneration capacity of 45 megawatts, with excess capacity of approximately5%.  Delivery of the three units is scheduled for the fourth quarter2009.  See “Liquidity,Capital Resources and Capital Expenditures” for further detail regarding theAgreement.

 

Initially,we expect that funding of payments due under the Agreement may come from anon-lending arrangement (loans between our subsidiaries) contained in the $215million reserve-based lending facility. After the $120 million project financing mentioned above is closed andfunded as expected, any amounts borrowed under the on-lending arrangement fromthe $215 million reserve-based lending facility will be repaid from thoseproceeds.  For a more detailed descriptionof the on-lending arrangement from the $215 million reserve-based lendingfacility, see Note 9, “Long-Term Debt and Capital Lease Obligations”.

 

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

 

On June 26, 2008, weentered into a Memorandum of Understanding (“MOU”) with Shell ExplorationCompany (West) B.V. (“Shell”). This non-binding MOU establishes the basis forboth parties to move forward with negotiations for a possible joint ventureagreement with the ultimate goal of jointly developing Blocks Z-1, XIX andXXIII in Northwest Peru into large-scale oil and gas ventures, includingregional power generation, gas supply for local and regional industry, andliquefied natural gas (“LNG”). Our purpose in considering forming a joint ventureis to complement BPZ’s assets, local knowledge and experience, stakeholderrelationships, and vision with Shell’s technology, equipment, manpower andleadership, especially in gas marketing.

 

The purpose of the jointventure would be to accelerate the exploration of Blocks Z-1, XIX andXXII.  In addition, we would expect anagreement that includes, but is not limited to, the following fundamentalfeatures:

 

·                  Anunincorporated joint venture in Blocks Z-1, XIX and XXIII.

 

·                  BPZwould be the operator of record in the three blocks mentioned above.

 

·                  BPZwould initially retain 100% of the oil and gas assets in the Corvina, Delfinand Mero fields as well as 100% of the oil assets in the Albacora field, (the “Carved-outareas”) to enable BPZ to appraise the Carved-out areas. Shell would have theoption to buy a 50% interest in any one of these four Carved-out areas,beginning in July 2012 and 

 

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ending at an agreed time, at prevailing market prices. Additionally,Shell would join with BPZ to refurbish the platform and drill the first well inAlbacora.  BPZ would retain 100% of thepotential oil assets and 50% of the potential gas assets discovered in Albacorauntil such time Shell elects to exercise its option to buy the remaining 50%interest in the potential oil assets.

 

·                  BPZwould retain its 100% ownership of its planned gas-to-power project, subject toShell’s option to buy a 50% interest in the project at a later date.

 

·                  Shellwould commit to a three-phase exploration and appraisal program for up toapproximately $300 million. Shell has the option to exit at the end of eachphase. If Shell exercises its option to exit at the end of any phase, therespective participation would revert back to BPZ at no cost. The work programwould be focused on appraising the Mancora gas formation found in Blocks Z-1,XXIII and XIX and the deepwater prospects in Block Z-1, as well as otherprospects, thus enhancing BPZ’s ability to fulfill its commitments mandated bythe license contracts covering Blocks Z-1, XIX and XXIII. This program wouldprimarily consist of 2-D and 3-D seismic surveys in Blocks XXIII and Z-1,respectively, and the drilling of approximately 12 new wells. Shell and BPZwould share costs equally after the initial $300 million program.

 

·                  Anyfuture oil and/or prospective gas production, excluding that acquired from theCarved-out areas, would be shared by both parties.

 

·                  Incase sufficient gas is discovered to warrant a LNG project, BPZ and Shell wouldform a joint venture to develop the project, with Shell serving as theoperator.

 

However, both parties haveagreed that under no circumstance will an agreement be finalized for theacquisition of the Company’s rights in the three blocks until all necessaryboard of director, management and government approvals have been obtained andfully defined agreements have been negotiated and executed by both parties ortheir respective affiliated companies. Negotiations on the agreement with Shellare underway.  No assurances can be madethat such an agreement will be finalized and consummated.

 

**Resultsof Operations**

 

**Revenue**

 
| ** ** | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** ** | ** ** | **September 30,**                             | ** ** | **September 30,**                            | ** ** |
| ** ** | ** ** | **2008**                                           | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenue    |       | $                                                  | 33,440,330 |                                              | $          | — |   | $ | 44,843,046 |   | $ | — |   |
|            |            |                                                    |            |                                                   |            |  |  |  |  |  |  |  |  |

 

**We began producing oil on a limitedbasis in November 2007**from the CX11-21XD and 14D wells in the CorvinaField under an extended well testing program. During the second quarter 2008, we added production from the 18XD wellunder the extended well testing program. The oil is delivered by barge to the Petroperu refinery in Talara,located approximately 100 miles south of the platform.  The remainder is kept in production inventoryuntil we increase the inventory quantities to a sufficient level that the refineryin Talara will accept delivery.  We haveentered into two contracts for the sale of oil to Petroperu since we began oilproduction in November 2007.  Thefirst contract was for the sale of up to 200,000 barrels of oil to the refineryin Talara.  The contract was fulfilled inJune 2008.  The current salescontract with Petroperu is for the deliver of up to 400,000 barrels of oil tothe Talara refinery.  Similar to thefirst sales contract, the current sales contract is based on Northwest OilBasket pricing which is comprised of Oman, Fortes and Suez Blend pricing.  The unadjusted sales price is based on thepast five-day average before the crude oil delivery date.  The price is then discounted for the qualityof the oil delivered.  The determinationof quality is based on the gravity of the oil expressed in degrees, asdetermined under standards established by the American Petroleum Institute (“API”).  The price is discounted at a rate of 0.53% ofthe basket price per one degree API lower than the benchmark of 33 degrees APIas stipulated in the contract.  Inaddition a fixed premium of $0.75 per barrel is added to the price as a resultof the high diesel content of the crude oil.

** **

Royalties are calculated byPerupetro as stipulated in the Block Z-1 license agreement based on the sameNorthwest Oil Basket.  However, theircalculation is based on the past two week average price before the crude oildelivery date, as opposed to being based on the past five-day average pricebefore the crude oil delivery date.

 

The Corvina wells werevoluntarily shut-in as a result of the barge incident on January 30,2008.  Production resumed in full on June 9,2008, as a result of receiving the clearance needed to transport oil from theCX-11 platform to the 

 

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nearby Talara refinery by the correspondingPeruvian environmental agency.  Inaddition, our FPSO vessel was placed in position near the CX-11 platform andbegan receiving production from the platform during the second quarter ended June 30,2008.

 

During the three and ninemonths period ended September 30, 2008, we produced approximately 329,090barrels and 455,841 barrels, respectively. We sold approximately 322,171 barrels and 437,243 barrels during thethree and nine months ended September 30, 2008 at an average price, net ofroyalties, of approximately $103.80 per barrel and $102.56, respectively.  In January 2008, we incurredproduction and transportation delays due to the incident involving one of thePeruvian Navy tankers being used to transport oil to market. 1 “Oil Development— Corvina Field” above for a more detailed discussion of the incident. ** **Approximately 1,300 barrels of oil were lostin the fire aboard the tanker.  The costof the crude oil lost was approximately $62,000 and was expensed through leaseoperating expense and depreciation, depletion and amortization.

 

We had no oil sales duringthe three and nine months ended September 30, 2007.

 

**Operating Expenses**

 
| ** **                               | ** ** | **For the three months ended** | ** ** | **For the nine months ended** | ** ** |
|------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                               | ** ** | **September 30,**                             | ** ** | **September 30,**                            | ** ** |
| ** **                               | ** ** | **2008**                                           | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| General and administrative               |       | $                                                  | 10,406,515 |                                              | $          | 5,574,985 |   | $ | 28,644,083 |   | $ | 12,437,516 |   |
| Lease operating expense                  |       | 3,582,490                                          | ** ** | **—**                                        |       | 6,942,112 |   | — |   |
| Geological, geophysical and engineering  |       | 210,731                                            |       | 1,955,155                                         |       | 507,342 |   | 3,925,406 |   |
| Depreciation, depletion and amortization |       | 5,673,404                                          |       | 56,651                                            |       | 7,946,772 |   | 163,437 |   |
| Total operating expenses                 |       | $                                                  | 19,873,140 |                                              | $          | 7,586,791 |   | $ | 44,040,309 |   | $ | 16,526,359 |   |

 

Our operating expenses consist principally of general andadministrative costs including stock based compensation as well as geological,geophysical and engineering costs, lease operating costs and depreciation,depletion and amortization.

 

General and administrative costs have increased from $5,574,985 and$12,437,516 during the three and nine month period ended September 30,2007, respectively,  to $10,406,515 and$28,644,083, during the three and nine month period ended September 30,2008, respectively.  Included in generaland administrative expenses is stock-based compensationexpense.  The increase was due to Stock-basedcompensation expense for the three and nine months ended September 30,2008 was approximately $4,959,553 and $13,419,317 compared to $2,811,352 and$4,712,874 during the same period ended September 30, 2007.  Stock based compensation expense is primarilyrelated to our restricted stock grants, and accrued stock-based compensationunder our 2007 Long-Term Incentive Plan and 2007 Directors CompensationIncentive Plan.  We use equity incentivesto attract and retain key personnel.  Inaddition, the remaining increasein general and administrative is a result of the addition of necessarypersonnel to support our increased activity levels.

 

We incurred lease operating expense during the three and nine monthsended September 30, 2008 of $3,582,490 and $6,942,112, respectively, dueto the commencement of oil production. This amount includes approximately $38,000 related to the cost of theapproximately 1,300 barrels of oil that was lost as a result of the tankerincident.  As mentioned previously, wehad no oil production during the nine months ended September 30, 2007 andtherefore no lease operating expense during the same period.

 

Geological, geophysical and engineering cost for the three months endedSeptember 30, 2008 as compared to the same period ended September 30,2007 decreased significantly from $1,955,155 to $210,731, respectively, andfrom $3,925,406 to $507,342 for the nine month period ended September 30,2007 and September 30, 2008, respectively. The decrease is primarily due to performing 200 kilometers of 2-Dseismic in Block XIX during the quarter ended September 30, 2007 inaccordance with the Block XIX License Contract.

 

Depreciation, depletion and amortization increased significantly from$56,651 and $163,437 during the three and nine months ended September 30,2007, respectively, to $5,673,404 and $7,946,772 during the three and ninemonths ended September 30, 2008, respectively, primarily due to depletionexpense generated by oil production in the Corvina Field.  This amount includes approximately $24,000related to the cost of the approximately 1,300 barrels of oil that was lost asa result of the tanker incident.

 

We received net cash distributions from our investment in Ecuadorproperty of approximately $200,000 and $800,000 during the three and ninemonths ended September 30, 2008, respectively, compared to net cashdistributions of approximately 

 

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$242,844and $250,797 duringthe three and nine months ended September 30, 2007, respectively.  Since our investment consists of an interestin a producing oil and gas property, we are amortizing the investment on astraight-line basis over the remaining term of the license agreement coveringthe property.  Accordingly, we recorded$46,896 and $140,688 of amortization expense during the three and nine monthsended September 30, 2008, respectively, and the same amounts during thethree and nine months ended September 30, 2007.

 

We capitalized interest expense of $892,727 and $2,901,982 during thethree and nine months ended September 30, 2008, respectively, primarilyrelated to our capital lease obligations and the IFC convertible debt.  We incurred interest expense of approximately$2,939 and $4,104 during the three and nine months ended September 30,2007, respectively.

 

We received interest income of approximately $10,005 and $206,499during the three and nine months ended September 30, 2008, respectively,as compared to $256,557 and $754,304 during the three and nine months ended September 30,2007, respectively, as a result of the increased cash balances during the threeand nine months ended September 30, 2007 due to lower operating expenses.

 

Other income and (expense) increased from$(17,730) and $27,059 during the three and nine months ended September 30,2007, respectively, to $(68,146) and $155,847 for the three and nine monthsperiod ended September 30, 2008 respectively.  The increase for the three and nine monthsended September 30, 2008, is mostly due to realized foreign exchange rateloss of approximately $58,147 and an exchange rate gain of approximately$165,637, respectively.  The exchangerate gain is primarily related to the early recovery of IGV or Value AddedTaxes in Peru.  IGV under the earlyrecovery program is denominated in the Peruvian Nuevo Sol currency.  However, the total gain during the ninemonths ended September 30, 2008 was partially offset in the third quarterby Nuevo Sol denominated accounts payable being settled during thequarter.  A net foreign currency gain wasrealized due to the strengthening of the Nuevo Sol against the US Dollar. See Item3. Quantitative and Qualitative Disclosures About Market Risk, “*Foreign Currency Exchange Rate Risk”* for a more detaileddiscussion.

 

We recognized a total tax provision for thethree and nine months ended September 30, 2008 of approximately $5,050,821and $5,291,401, respectively, compared to tax gain of $11,301 and a tax loss of $39,001for the same periods ended September 30, 2007.  The difference is primarily due to oil salesfrom our production in Block Z-1 during the three months ended September 30,2008.  We are subject to Peruvian incometax on our earnings at a statutory rate, as defined in the Block Z-1 LicenseContract, of 22%.  Because we are underan extended well testing program from which we will finalize a development planfor Block Z-1 we have not moved into the commercial phase of production asdefined by the license contract.  Assuch, certain deductions are disallowed by the Peruvian tax regime while theCompany operates under the extended well testing program.  In addition, the tax provision amountis based on taxable Peruvian income that excludes certain U.S. expenses thatare not deductible at the Peruvian level. The tax expensein 2007 is related to the revenues from our 10% non-operated workinginterest in the Santa Elena Property in southwestern Ecuador and its affect onour US non-consolidated returns.  We wereunable to offset the operating losses generated from our Peruvian branch withthe revenues from our Ecuador branch.

 

We realized net income of $8,611,332 or $0.11 per basic and dilutedshare and a net loss of $(3,467,006) or $(0.05) per basic and diluted shareduring the three and nine months ended September 30, 2008, respectively,compared to a net loss of $(7,159,220) or $(0.10) per basic and diluted shareand $(15,847,543) or $(0.23) per basic and diluted share for the same periodsin 2007.  The net income was due to oilrevenues during the nine months ended September 30, 2008 compared with nooil revenues during the nine months ended September 30, 2007.

 

**Liquidity,Capital Resources and Capital Expenditures**

 

Prior to generating significant revenue fromCorvina oil sales, our primary source of cash flow was cash proceeds fromprivate and public placements of our common stock and limited debtfacilities.  At September 30, 2008we had a working capital deficit of $17.5 million.

 

As of October 31, 2008, our cash balancewas approximately $14.4 million. With our current cash balance, proceeds from the expected additional IFCand Natixis debt facilities, current Corvina Oil development cash flow, otherpotential third-party financing and potentially from future equity raises, asdescribed below, we believe we will have sufficient capital resources toexecute our initial Corvina oil development project, Albacora oil developmentproject and gas-to-power project as we currently envision them.  However, the timing and execution of ourproject is dependent on a variety of factors, including the technical design offacilities, permitting, availability of equipment, time and costs required fordelivery and construction, performance by contractors and the success ofplanned financing, many of which are factors outside our control and cannot beassured.

 

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*Production*

 

**We began producing oil on a limitedbasis in November 2007**from the CX11-21XD and 14D wells in the CorvinaField under an extended well testing program. During second quarter 2008, we added production from the 18XD well.  The oil is delivered by barge to thePetroperu refinery located approximately 100 miles south of the platform.  The remainder is kept in production inventoryuntil we increase the inventory quantities to a sufficient level that therefinery in Talara will accept delivery. Our current sales contract with Petroperu is based on Northwest OilBasket pricing which is comprised of Oman, Fortes and Suez Blend pricing.  The unadjusted sales price is based on thepast five-day average before the crude oil delivery date.  The price is then discounted for the qualityof the oil delivered.  The determinationof quality is based on the gravity of the oil expressed in degrees, asdetermined under standards established by the American Petroleum Institute (“API”).  The price is discounted at a rate of 0.53% ofthe basket price per one degree API lower than the benchmark of 33 degrees APIas stipulated in the contract.  In additiona fixed premium of $0.75 per barrel is added to the price as a result of thehigh diesel content of the crude oil.

** **

Royalties are calculated byPerupetro as stipulated in the Block Z-1 license agreement based on the sameNorthwest Oil Basket.  However, theircalculation is based on the past two week average price before the crude oildelivery date, as opposed to being based on the past five-day average beforethe crude oil delivery date.

 

The Corvina wells werevoluntarily shut-in as a result of the barge incident on January 30,2008.  Production resumed in full on June 9,2008, as a result of receiving the clearance needed to transport oil from theCX-11 platform to the nearby Talara refinery by the corresponding Peruvianenvironmental agency.  In addition, ourFPSO vessel was placed in position near the CX-11 platform and began receivingproduction from the platform during the second quarter ended June 30,2008.

 

During the three and ninemonth period ended September 30, 2008, we produced approximately 329,090barrels and 455,841 barrels, respectively. We sold approximately 322,171 barrels and 437,243 barrels during thethree and nine months ended September 30, 2008 at an average price, net ofroyalties, of approximately $103.80 per barrel and $102.56, respectively.  In January 2008, we incurredproduction and transportation delays due to the incident involving on of thePeruvian Navy tankers being used to transport oil to market.  See Note 1, “Basis of Presentation andSignificant Accounting Policies — Corvina” above for a more detail discussionof the incident.****Approximately 1,300 barrels of oil were lost in the fire aboard thetanker.  The cost of the crude oil lostwas approximately $62,000 and was expensed through lease operating expense anddepreciation, depletion and amortization.

 

We had no oil sales duringthe three and nine months ended September 30, 2007.

 

Weare currently using two tank barges under a capital lease agreement as afloating production and storage facility (“FPSO”) and a transport barge.  The two barges under a capital lease, theNamoku and the Nu’uanu, each have a capacity of approximately 40,000barrels.  The Namoku is being used as aFPSO, moored adjacent to the CX-11 platform, while the Nu’uanu is being used totransport oil between the Corvina field off shore in northwest Peru in the Z-1block and the Petroperu refinery in Talara located approximately 100 milessouth of our operations.

 

The FPSO, theNamoku, as well as the storage barge, the Nu’uanu, are under a separate capitallease agreement.  The capital lease forthe production equipment commenced in June 2008, the date the equipmentwas put into service.  The lease termsare variable and bear an interest rate of 18% based on the Company’sincremental borrowing rate for similar equipment.  In accordance with the terms of the lease, abargain purchase option exists at the end of the lease.  As a result, depreciation will be calculatedover the economic life of the asset.  TheCompany recorded the capital lease at $2.4 million, which represents thepresent value of the minimum lease payments at the Company’s incrementalborrowing rate over the term of the lease, or the fair market value of theasset.

 

*Capital Raises and Debt Activity*

 

On March 25, 2008,we closed on a public offering of 2.0 million shares of common stock .  The offering was priced to the public at$20.00 per share and underwritten by Canaccord Adams, Inc. (“Canaccord”)on a firm commitment basis.  We receivedproceeds after underwriting fees and discounts of approximately $37.5million.  In addition, we grantedCanaccord a 30-day option to purchase up to 200,000 additional shares to coverany over-allotments.  On April 18,2008, the over-allotment option was executed and Canaccord bought an additional200,000 shares resulting in proceeds to us after underwriting fees anddiscounts of approximately $3.6 million. A financial advisory fee of $150,000 was paid to Morgan Keegan forinvestment services and consulting related to the offering.

 

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We have used the proceeds from the offeringfor general corporate purposes, including: the reduction of outstandingindebtedness, or other corporate obligations, capital expenditures and generalworking capital requirements, including testing and drilling operations andcommencement of development of our Albacora Field property.

 

As of September 30, 2008, we had long-term debtand capital lease obligations outstanding of $22,580.  On November 19, 2007, we entered into aconvertible debt agreement (“C Loan”) between IFC for approximately $15.5million.  The terms of the loan agreement stipulated a conversion price of$10.39 per share and included a forced conversion exercisable at our option ifthe closing price of the our common stock exceeded a price of $18.19 per share,based on the average closing price over twenty consecutive business days.  In May 2008, we converted this long-termdebt into 1,491,819 shares of our common stock and settled approximately $15.5million in long-term debt.  TheIFC currently owns approximately 10% of the Company’s outstanding common stock.

 

We are actively negotiating with IFC to increase the debt package to anestimated $350 million for further development of its assets, of which $120million of the total financing package was approved by the Credit Committee ofthe IFC on November 29, 2006 and $200 million was approved by the NatixisCredit Committee on September 4, 2008. See Note 14 “Commitments and Contingencies – *FinancingPackage”* in the Company’s form 10-K, as amended, for the periodended December 31, 2007 for further discussion.  Part of the debt issuance was fundedthrough a “C” Loan, as described above. We anticipate the remaining debt issuance balance to be funded throughthe following two debt facilities:

 

·                                       On August 18,2008, we entered into a $15.0 million reserve-based lending facility (the “LoanAgreement”) with IFC through our subsidiaries BPZ Exploracion &Produccion S.R.L and BPZ Marine Peru S.R.L as borrowers.  The $15 million lending facility representsthe first tranche of an expected overall lending package of $215 million.  The proceeds will primarily be used to fundthe GE Turbines purchase.  Thereserve-based lending facility matures in December 2012 and bears interestat an approximate rate of LIBOR plus 2.75%, currently equivalent to 5.85% basedon the current six month LIBOR rate of 3.1%.  The maximum amount availableunder this facility will begin at $15.0 million and will be reduced by $2.5million beginning on December 16, 2010 and every six months thereafterduring the term of the Loan Agreement.  The facility is subject to asemi-annual borrowing base determination based on the value of oilreserves.  In addition, we are subject to various financial covenantscalculated as of the last day of each quarter, including a life of fieldcoverage ratio, life of loan coverage ratio, debt to equity ratio and interestcover ratio. We were in compliance with all applicable covenants of the LoanAgreement as of September 30, 2008. Funding for the initial $15.0 million facility was subject to satisfyingcertain conditions precedent which were fulfilled on October 17, 2008 andthe entire $15.0 million was drawn down.

 

TheLoan Agreement provides for events of default customary for agreements of thistype, 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 financing documents withthe IFC, the development and operation of the Corvina Field in Block Z-1, anyadditional petroleum assets under license contracts with Perupetro or certainother key agreements; revocation of any financing or security documents withthe IFC or certain key agreements; defaults on certain liabilities; 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 an event of defaultoccurs, IFC and any additional facility agent may (i) terminate all orpart of the relevant facility; (ii) declare all or part of the principalamount of the loan, together with accrued interest, immediately due andpayable;  (iii) declare all or part of the principal amount of theloan, 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.

 

On September 4, 2008, Natixis,a major French bank, the co-facility agent with IFC, obtained approval from itsCredit Committee to arrange and underwrite the second tranche of $200million.  This second tranche of the $215 million reserve-based lending facilityis currently being negotiated with Natixis and is 

 

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expected to close in fourthquarter 2008.We willdraw down on the facility only when necessary. Initial available funding of approximately $60 million is expectedshortly thereafter subject to meeting certain conditions precedent to funding.  The remaining $140 million will be madeavailable as the lending syndicate is identified, which is expected to occur inearly 2009.

 

·                                               We arenegotiating an additional $120 million debt facility to fund the development ofits gas-to-power project.  The finalnumber will be a function of the type of generation equipment ultimatelyselected.  We are currently negotiatingthe engineering, procurement and construction contracts that will be conditionsprecedent to this credit facility.  Weanticipate closing this loan by mid 2009.

 

As of November 7, 2008, the final loan documents for the $200million reserve-based lending facility and $120 million loans have not beencompleted and are subject to final negotiations, documentation and satisfactionof certain conditions.

 

During the ninemonths ended September 30, 2008, we entered into two loan agreements withPeruvian banks to borrow approximately $2.8 million.  The loans were collateralized by IGVreceivables and bore interest rates of approximately 8% each.  The Company paid off the entire outstandingbalance as of September 30, 2008.

 

*Equipment Activity*

 

During the nine months ended September 30,2008, we incurred capital expenditures of approximately $77.7 millionassociated with our development initiatives for the exploration and productionof oil and natural gas reserves and the complementary development ofproprietary gas-fired power generation of electricity for sale in Peru.

 

Of the incurred costs mentioned above, we incurred capital expendituresrelated to the drilling and testing of the CX11-18XD of approximately $19.0million during the nine months ended September 30, 2008.  We performed three drill stem tests of theCX11-18XD.  The three drill stem tests were conducted inthe Upper Zorritos formation.  The firsttwo drill stem tests targeted the lower sands in zones that had not previouslybeen tested.  The third drill stem testtargeted sands that had tested oil in the Company’s CX11-21XD well.  We began producing from the 18XD well in May of2008.

 

In addition, we spudded the CX11-20XD well inMay 2008.  The CX11-20XD well ispositioned higher up in the geologic structure from the CX11-21XD well.  The well has been positioned to furtherdevelop the top gas sands found in the previously drilled 21XD well, the oilssands currently producing in the 21XD and 18XD wells, the oil sands encounteredand briefly tested in the 18XD well during the initial drill-stem test numberone, as well as sands found in the 14D well. The well tested positive for oil in quantities that we believe tobe commercially producible.  We completedtwo drill stem tests on four sets of oil sands in the well.  Currently, We intend to complete theCX11-20XD well as an oil-producing well under the extended well testing programcurrently ongoing at the Corvina field. However, because the well crosses sandswhich tested positive for what we believe to be economic quantities of gas inboth the 21XD and 18XD wells, we intend to re-complete the CX11-20XD well toallow the well to produce both gas and oil when the gas is needed for ourgas-to-power project.  Totalcapital expenditures incurred on this well for the nine months ended September 30,2008 is approximately $25.3million.

 

We intend to spud the CX11-15D well by mid-November 2008.  We expect this well to take approximately 90days to reach total depth, and to be tested and completed in early 2009.  The 15D well represents the final well to bedrilled from the CX-11 platform under the initial Corvina drillingprogram.  Upon completion of the CX11-15Dwell, we intend to focus our drilling efforts on the Albacora field located inthe northern part of its offshore Block Z-1.

 

We also incurred costs ofapproximately $9.3 million during the nine months ended September 30, 2008for the installation of sea-bed pipelines and a new mooring system as a resultof placing the FPSO into service.  Thisnew program should enable us to initiate production in a more efficient mannerwhich will allow for a better understanding of the behavior and characteristicsof the Corvina oil field.

 

In preparation forour drilling campaign in Albacora, we performed well control on the existingwell heads located at the platform.  Weincurred approximately $1.5 million in well control costs to provide a safeenvironment to begin the refurbishment of the A-1 platform.

 

In February 2008, we entered into a lease-purchase agreement toacquire the BPZ-02 for approximately $7.0 million.  The BPZ-02 is a deck barge approximately 330feet in length.  It will assist in theplatform refurbishment and drilling activities in the Albacora field as well asto assist in future offshore drilling and development activities.  In thenear term, the 

 

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BPZ-02 is being used to actas a tender assist for the Petrex drilling rig until it is moved to theAlbacora field in first quarter 2009.  During that time, as mentioned inNote 15 “Commitment and Contingencies”, the BPZ-01 will be placed in dry-dockto repair damages sustained when it ran aground in late 2006.  Theacquisition of the BPZ-02 allows us better asset maintenance scheduling andwill aid in the support of increased offshore exploration and developmentactivities.  The terms of the lease-purchase stipulate a 19% rate ofinterest (33% effective rate of interest) over a one-year term at which point,title to the BPZ-02 will transfer to us upon final payment of the lease. We are accounting for the transaction as a Capital Lease in accordance to SFAS13, “Accounting For Leases (As Amended)” under the applicable criteria, titleto the barge will transfer at the end of the lease period and, as a result,depreciation will be calculated over the economic life of the asset.

 

In addition, we entered into a capital lease agreement for theproduction equipment on board the FPSO. The FPSO, the Namoku, as well as the storage barge, the Nu’uanu, areunder a separate capital lease agreement. The capital lease for the production equipment commenced in June 2008,the date the equipment was put into service. The lease terms are variable and bear an interest rate of 18% based onour incremental borrowing rate for similar equipment.  In accordance with the terms of the lease, abargain purchase option exists at the end of the lease.  As a result, depreciation will be calculatedover the economic life of the asset.  Werecorded the capital lease at $2.4 million, which represents the present valueof the minimum lease payments at our incremental borrowing rate over the termof the lease, or the fair market value of the asset.

 

We continue to work on the development of aCompany-owned gas-fired power generation facility.  We incurred costs of approximately $3.6million related to the drafting of certain design specifications for the powerplant.  In addition, on September 26,2008, we entered into a $51.5 million contract through our subsidiary, EmpresaEléctrica Nueva Esperanza, SRL (the “Subsidiary”), for purchase of equipmentand services (the “Agreement”) with GE Packaged Power, Inc. and GEInternational, Inc. Sucursal de Peru, which are part of GE Energy’saeroderivative business.  The Agreement obligates us to purchase threeLM6000 gas-fired turbines, with an option to purchase a fourth unit, andrequires an initial down payment of $5.1 million.

 

Should our Subsidiary fail to timely make progresspayments on the turbines due by December 15, 2008, or fail to provide acomfort letter from the facility agents by December 15, 2008 as requiredby the Agreement, then we will be required to provide a corporate guaranty ofour Subsidiary’s remaining payments on or before December 18, 2008. The corporate guaranty is conditioned upon us meeting a financial test ofearnings before interest, taxes, depreciation, amortization, and exploratoryexpenses (not to exceed $5 million) for the three month period ending October 31,2008 equal to or greater than 2.25 times the sum of payments due for the periodbetween January and March of 2009. If the financial test is not met,our Subsidiary will be required to provide a standby letter of credit. Our Subsidiary may replace the standby letter of credit with our corporateguaranty if we later meet the financial test for any subsequent three monthperiod.

 

We also incurred costs for office equipment and leasehold improvementsfor our offices in Houston, Peru and Ecuador of approximately $0.3 million andfor the purchase of machinery and equipment used in operations in Peru ofapproximately $0.6 million.

 

In accordance with “successful efforts” method of accounting, wecapitalized approximately $245,062 and $658,474 of depreciation expense mainlyrelated to the tender assist barges serving as support equipment, toconstruction in progress for the three and nine month period ended September 30,2008, respectively.  In addition, wecapitalized interest expense for the three and nine months ended September 30,2008 of approximately $892,727 and $2,901,982, respectively, to construction inprogress.

 

*Performance Bonds*

 

Inconnection with its properties in Peru, we have obtained five performance bondstotaling $8.0 million to insure certain obligations and commitments, of whichone related to the guarantee of import duties related to the FPSO and transporttanker and four relate to performance obligations under the license contractsfor Blocks Z-1, XIX, XXII and XXIII.  As of September 30,2008, we had restricted cash deposits of $5.9 million, which partiallycollateralizes the performance bonds.

 

During the nine months ended September 30,2008, we were refunded $0.3 million related to the second exploration phaseunder the Block XIX license contract and approximately $1.0 million related toa performance commitment under a drilling services contract.  We were required to post a $0.6 millionperformance bond in connection with the third phase of exploration under theBlock XIX license contract.  We alsoposted a $2.8 million bond to guarantee import duties for the FPSO barge andtransport tanker as well as the BPZ-02.

 

All of the performance bonds are issued by Peruvian banks and theirterms are governed by the corresponding license contract.

 

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*ExplorationActivity*

 

In connection with the Block XIX licensecontract, during the second quarter 2007, we began shooting 200 kilometers of2-D seismic. The work was completed during the third quarter 2007.  The cost to acquire this seismic data wasapproximately $3.6 million.  Based on theresults of the 2-D seismic surveys and in order to comply with the requirementsunder the next phase of the related license contract, we plan to drill a wellin Block XIX in early 2009 at an estimated cost of $8.0 million.

 

**Off-BalanceSheet Arrangements**

 

As of September 30, 2008, we had no transactions, agreements orother contractual arrangements with unconsolidated entities or financialpartnerships, often referred to as special purpose entities, which generallyare established for the purpose of facilitating off-balance sheet arrangements.

 

**ContractualObligations**

 
| ** **                    | ** ** | **Payments Due by Period at September 30, 2008** | ** ** |
|-------------------------------|------------|-------------------------------------------------------------------------------------|------------|
| ** **                    | ** ** | ** **                                                                          | ** ** | **Less Than** | ** ** | **One to** | ** ** | **Three to** | ** ** | **More Than** | ** ** |
| ** **                    | ** ** | **Total**                                                                           | ** ** | **One Year** | ** ** | **Three Years** | ** ** | **Five Years** | ** ** | **Five Years** | ** ** |
| **Contractual Obligations:**  |       |                                                                                |       |   |   |   |   |   |   |   |   |
| Operating lease obligation(1) |       | $                                                                                   | 397,408    |   | $ | 212,894 |   | $ | 184,514 |   | $ | — |   | $ | — |   |
| Debt obligation(2)            |       | 10,668,080                                                                          |       | 10,644,618 |   | 23,462 |   | — |   | — |   |
| Purchase obligation (3)       |       | 46,318,500                                                                          |       | 39,456,500 |   | 6,862,000 |   |   |   |   |   |
| Total                         |       | $                                                                                   | 57,383,988 |   | $ | 50,314,012 |   | $ | 7,069,976 |   | $ | — |   | $ | — |   |

 

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| (1)    |   | Operating leases  for our executive office in Houston, Texas, our branch office in Quito,  Ecuador, and our branch office and corporate apartments in Lima, Peru.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (2)    |   | Includes capital lease for two production  and storage barges which began in August 2007 and is set to expire in  November 2009. Lease payments are variable based on the working status  of the barges, with a purchase option of $5,000,000 after the first year of  the lease and $4,000,000 after the maturity date of the lease. Also, includes  lease-purchase of the BPZ-02 which stipulates a 19% rate of interest (33% effective  rate of interest) over a one-year term at a fixed rate of payment of  $694,167. At the end of the term, title to the BPZ-02 will transfer to us  upon final payment of the lease. In addition, includes the $2.4 million  capital lease of the production equipment onboard the Floating Production  Storage and Offload Facility, the Namoku. The lease terms are variable  and bear an interest rate of 18% based on our incremental borrowing rate for  similar equipment. In accordance with the terms of the lease, a bargain  purchase option exists at the end of the lease. Lastly, includes the capital lease for office furniture in our  executive office in Houston, Texas expiring in 2010. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| (3)    |   | Purchase of three LM6000 gas-fired turbines, with an  option to purchase a fourth unit, and requires an initial down payment of  $5.1 million.  Monthly progress payments of $1.1 million will commence  in October 2008 for the first unit, $2.3 million in November 2008  for both the first and second units, $3.4 million in December 2008 through  September of 2009 for all three units, $2.3 million in October of  2009 for two units and $1.1 million in November of 2009 for the final  unit.  A final payment of $1.7 million per unit ($5.1 million total) is  due five days after the issuance of the seller’s Notice of Readiness to Ship  for each unit.  The contract also contains an option to purchase one  additional unit for $18.2 million.                                                                                                                                                                                                                                                                                                                                           |

 

**CriticalAccounting Policies and Recent Accounting Pronouncements**

 

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

 

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In Item 7 “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” of our Annual Report on Form 10-K,as amended, for the year ended December 31, 2007, we identified our mostcritical accounting policies upon which our financial condition depends asthose relating to oil reserves, successful efforts method of accounting,revenue recognition, impairment of long-lived assets, future dismantlement,restoration, and abandonment costs, as well as stock-based compensation.

 

***In addition, in May 2008, the FASB issued SFAS No. 162,“The Hierarchy of Generally Accepted Accounting Principles,” which identifiesthe sources of accounting principles and the framework for selecting theprinciples used in the preparation of financial statements of nongovernmentalentities that are presented in conformity with generally accepted accountingprinciples (GAAP) in the United States of America. This statement iseffective 60 days following the SEC’s approval of the Public CompanyAccounting Oversight Board amendments to AU Section 411, “The Meaning ofPresent Fairly in Conformity with Generally Accepted Accounting Principles.”The Company does not expect the adoption of SFAS No. 162 to have amaterial impact on its consolidated financial position, results of operationsor cash flows.***

*** ***

Also in June 2008, the FASB issued StaffPosition No. EITF 03-6-1 “Determining Whether Instruments Granted inShare-Based Payment Transactions Are Participating Securities,” (“FSP EITF03-6-1”), which provides that unvested share-based payment awards that containnonforfeitable rights to dividends or dividend equivalents (whether paid orunpaid) are participating securities and, therefore, need to be included in theearnings allocation in computing earnings per share under the two class method.FSP EITF 03-6-1 is effective for us on January 1, 2009 and allprior-period EPS data (including any amounts related to interim periods,summaries of earnings and selected financial data) will be adjustedretroactively to conform to its provisions. Early application of FSP EITF03-6-1 is not permitted. Although restricted stock awards meet this definition,the Company does not expect the application of FSP 03-6-1 to have a significantimpact on its reported earnings per share.

 

**DisclosureRegarding Forward-Looking Statements**

 

We cautionthat this document contains forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995, Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  All statements, other thanstatements of historical facts, included in or incorporated by reference intothis Form 10-Q which address activities, events or developments which weexpect, believe or anticipate will or may occur in the future areforward-looking statements.  The words “believes,”“intends,” “expects,” “anticipates,” “projects,” “estimates,” “predicts,” “plans”and similar expressions, or the negative thereof, are also intended to identifyforward-looking statements.  Inparticular, statements, expressed or implied, concerning future operatingresults, the ability to replace or increase reserves, or to increaseproduction, or the ability to generate income or cash flows are by nature,forward-looking statements.  Thesestatements are based on certain assumptions and analyses made by the managementof BPZ in light of its experience and its perception of historical trends,current conditions and expected future developments as well as other factors itbelieves are appropriate in the circumstances. However, forward-looking statements are not guarantees of performanceand no assurance can be given that these expectations will be achieved.

 

Importantfactors that could cause actual results to differ materially from theexpectations reflected in the forward-looking statements include, but are notlimited to any of the following in the jurisdictions in which BPZ or itssubsidiaries are doing business:  Marketconditions, uncertainties inherent in oil and gas production operations andestimating reserves, unexpected future capital expenditures, the timing andextent of changes in commodity prices for crude oil, natural gas and relatedproducts, currency exchange rates, interest rates, inflation, the availabilityof goods and services, drilling and other operational risks, successfulinstallation and operation of the new turbines, availability of capitalresources, timing of syndication of and disbursements under the anticipateddebt financing with IFC and Natixis, legislative or regulatory changes,political developments, acts of war and terrorism.  A more detailed discussion on risks relatingto the oil and natural gas industry and to us is included in our Annual Reporton Form 10-K,as amended, for the year ended December 31,2007.

 

In light ofthese risks, uncertainties and assumptions, we caution the reader that theseforward-looking statements are subject to risks and uncertainties, many ofwhich are beyond our control, which could cause actual events or results todiffer materially from those expressed or implied by the statements.  All subsequent written and oralforward-looking statements attributable to us or persons acting on our behalfare expressly qualified in their entirety by the cautionary statements.  We undertake no obligations to update orrevise its forward-looking statements, whether as a result of new information,future events or otherwise.

 

**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

The primary objective of the following information is to provideforward-looking quantitative and qualitative 

 

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information about our potential exposure to market risks.  The term “market risk” refers to the risk ofloss arising from adverse changes in interest rates, oil and natural gas pricesand foreign currency exchange rates.  Thedisclosures are not meant to be precise indicators of expected future losses,but rather indicators of reasonable possible losses.  This forward-looking information providesindicators of how we view and manage our ongoing market risk exposures.  All of our market risk sensitive instrumentswere entered into for purposes other than speculative trading.

 

*InterestRate Risk.*

 

As of September 30, 2008, we had long-term debt and capital leaseobligations of approximately $22,580 and current maturities of long-term debtand capital lease obligations of approximately $10.2 million, consisting ofthree capital lease obligations for two barges and production equipment and twoloans for office furniture

 

The firstcapital lease obligation is for the FPSO barges which began in August 2007and is set to expire in November 2009. Lease payments are variable basedon the working status of the barges, with a purchase option of $5,000,000 afterthe first year of the lease and $4,000,000 after the maturity date of thelease.  The capital lease obligation hasan imputed interest rate of 18.00% over a lease term.  The second capital lease obligation contains a lease-purchase option and stipulates a 19%rate of interest (33% effective rate of interest) over a one year term, atwhich point title to the BPZ-02 will transfer to us upon final payment of thelease.  The third capital leaseobligation is for the production equipment on board the FPSO barge, the Namoku,and contains a purchase option at the end of twelve months and stipulates aninterest rate of 18.0%.  We have two additional loans foroffice equipment containing a term of 60 months and bearing fixed interestrates of 5.94% and 9.44%, respectively, with principal and interest paymentsdue on a monthly basis.

 

We do not expect a significant change in the market interest rate toimpact the interest on our term debt. However, significant changes in market interest rates may significantlyaffect the level of financing that the IFC will structure with respect to ourproject in Peru.

 

*CommodityPrice Risk.*

 

With respect to our oil and gas business, any revenues, cash flow,profitability and future rate of growth we achieve will be greatly dependentupon prevailing prices for oil and gas. Our ability to maintain or increase our borrowing capacity and to obtainadditional capital on attractive terms is also expected to be dependent on oiland gas prices.  Historically, oil andgas prices and markets have been volatile and are likely to continue to bevolatile in the future.  Prices for oiland gas are subject to potentially wide fluctuations in response to relativelyminor changes in supply of and demand for oil and gas, market uncertainty, anda variety of additional factors that are beyond our control.

 

Lower oil and natural gas prices may not only decrease our revenues ona per unit basis, but may also reduce the amount of oil and natural gas we canproduce economically, if any.  Asubstantial or extended decline in oil and natural gas prices may materiallyaffect our future business, financial condition, results of operations,liquidity and borrowing capacity, and we may require a reduction in thecarrying value of our oil and gas properties. While our revenues may increase if prevailing oil and gas pricesincrease significantly, exploration and production costs and acquisition costsfor additional properties and reserves may also increase.

 

With respect to our planned electricity generation business, the pricewe can obtain for the sale of power may not rise at the same rate, or may notrise at all, to match a rise in the Company’s cost to produce and transport gasreserves to our initial 135MW power plant in Caleta Cruz.  Prices for both electricity and natural gas havebeen very volatile in the past year and have increased significantly over thepast two years.  The profitability ofthis business depends in large part on the difference between the price ofpower and the price of fuel used to generate power, or “spark spread.”

 

*ForeignCurrency Exchange Rate Risk.*

 

The U.S. Dollar is the functional currency for our operations in bothPeru and Ecuador.  Ecuador has adoptedthe U.S. Dollar as its official currency. Peru, however, uses its local currency, Nuevo Soles, in addition to theU.S. Dollar, and therefore, our financial results are subject to favorable orunfavorable fluctuations in the exchange rate and inflation in thatcountry.  Transaction differences havebeen nominal to-date but are expected to increase as our activities in Perucontinue to escalate.  During the threeand nine months ended September 30, 2008, we realized an exchange rateloss of approximately $58,147 and an exchange rate gain of approximately$165,637, respectively.  The exchangerate gain is primarily related to the early recovery of IGV or Value AddedTaxes in Peru.  IGV under the earlyrecovery program is denominated in the Peruvian Nuevo Sol currency.  However, the total gain during the ninemonths ended September 30, 2008 was partially offset in the third quarterby Nuevo Sol denominated accounts payable being settled during thequarter.  A net foreign currency gain 

 

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was realized due to the strengthening of the Nuevo Sol against the USDollar.

 

**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 this reportto ensure that information required to be disclosed by the Company in thereports that the Company files or submits under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules 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 September 30,2008, there was no change in internal control over financial reporting thatmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

**PART II**

 

**Item 1. Legal Proceedings**

 

See Note 15, “Commitments andContingencies”, of the Notes to Consolidated Financial Statementsincluded in Part I, Item I, of the December 31, 2007 Form 10-K, as amended, which is incorporatedherein by reference.

 

In addition, on October 24, 2007, ourformer primary marine transportation contractor entered into two short termagreements with the commercial division of the Peruvian Navy to lease twotankers to transport oil to market.  On January 30,2008, one of the tankers, the Supe, sank after catching fire.  At the time of the incident, the tankercontained approximately 1,300 barrels of oil. No Company employees wereinjured. Official environmental impact assessments concluded that environmentalissues have been adequately controlled. Even though no civil claims havebeen asserted against us as a result of the Supe incident, we believe that we,as a contracting party, and our third party marine contractor, as the timecharterer of the Supe, may have limited exposure to civil liability resultingfrom the Supe incident.  However, we consider any such liability to beremote and that such limited exposure, while unknown at this time, will nothave a material effect on our financial statements.

 

**Item 1A. Risk Factors**

 

Item 1A, “Risk Factors” of our Annual Reporton Form 10-K, as amended, for the year ended December 31,2007, includes a detailed discussion of our risk factors.  Except as set forth below, there are nomaterial changes in our risk factors as previously described in our AnnualReport on Form 10-K, asamended, for the year ended December 31, 2007.

 

***Construction andoperation of power generation and gas processing facilities and pipelinesinvolve significant risks and delays that cannot always be covered by insuranceor contractual protections.***The construction of power generation and gas processing facilities andpipelines involve many risks, including:

 

·              supply interruptions,

 

·              work stoppages,

 

·              labor disputes,

 

·              social unrest,

 

·              inability to negotiate acceptableconstruction, supply or other contracts,

 

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·              inability to obtain required governmentalpermits and approvals,

 

·              weather interferences,

 

·              unforeseen engineering, environmental andgeological problems,

 

·              unanticipated cost overruns,

 

·              possible delays in the acquisition of thenecessary gas turbines,

 

·              possible delays in connection with powerplant construction,

 

·              possible delays or difficulties in completingfinancing arrangements for the gas-to-power project, and

 

·              possible difficulties or delays with respectto any necessary Peruvian regulatory compliance.

 

The ongoing construction and future operation ofthese facilities involves all of the risks described above, in addition torisks relating to the breakdown or failure of equipment or processes andperformances below expected levels of output or efficiency. We intend tomaintain commercially reasonable levels of insurance where such insurance isavailable and cost-effective, obtain warranties from vendors and obligatecontractors to meet certain performance levels. However, the coverage orproceeds of any such insurance, warranties or performance guarantees may not beadequate to cover lost revenues or increased expenses. Any of these risks couldcause us to operate below expected capacity levels, which in turn could resultin lost revenues, increased expense and higher maintenance costs.

 

***Our successdepends in part on the existence and growth of markets for natural gas andelectricity in Peru and Ecuador.***Peru has a relatively well-developed and stable market for electricity,while the power market in Ecuador is not as well-developed or stable. Bothcountries rely on hydro-electric generating capacity for a significant portionof their power demand. Hydro plants are much less expensive to operate thanplants that utilize natural gas, but they are subject to variable output basedon rainfall and reservoir levels. The majority of the non-hydro, or thermal,power capacity in both countries consists of generating plants that utilizediesel or fuel oil, which are significantly more costly than natural gas atthis time. Both countries have natural gas reserves and production, but neitherhas a well-developed natural gas infrastructure. Our immediate business planrelies on the continued stability of the power market in Peru (and Ecuador forthe purpose of gas sales to third-party power producers in Ecuador), and ourlonger-term plans depend on the further development of the electricity marketin Ecuador. We currently do not expect to complete our power plant until mid2010.  Our assessment of the future power market and demand in Peru andEcuador could be inaccurate.  We are subject to the risks that:

 

·              Relatively more favorable business conditionsfor hydro plants, a material reduction in power demand or other competitiveissues may adversely affect the demand and prices for the electricity that weexpect to produce by the time our power plant is completed.

 

·              Our lifting costs could exceed the minimumwholesale power prices available, making the sale of our gas uneconomical.

 

·              Potential disruptions or changes toregulations of the natural gas or power markets in these countries could occurby the time our power plant is completed, or we may not receive the necessaryenvironmental or other permits and governmental approvals to operate our powerplant.

 

·              Although we plan to enter into long-termcontracts to sell a significant part of our future power production, there canbe no assurance that we will be successful in obtaining such contracts or thatthey will be on favorable terms.

 

·              We will also be subject to the generalcommercial issues related to being in the power business, including thecredit-worthiness of, and collections from, future customers and the ability toprofitably operate our future power plants.

 

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

 

None.

 

**Item 3. Defaults Upon Senior Securities**

 

None.

 

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

 

None

 

**Item 5. Other Information**

 

None.

 

**Item 6. Exhibits**

 
| 10.11  |   | Contract for Sale of  Equipment and Services dated September 26, 2008 (Filed herewith)                                                                                      |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                             |
| 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.

 
| Date: November 10, 2008 |     |                                              |
|------------------------------|----------|---------------------------------------------------|
|                         |     |                                              |
|                         |     | BPZ RESOURCES, INC.                               |
|                         |     |                                              |
| * *                     | * * | */s/ Manuel Pablo Zúñiga-Pflücker* |
|                         |     | Manuel Pablo  Zúñiga-Pflücker      |
|                         |     | President and Chief  Executive Officer            |

 

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