Masters Energy Inc.
TSX : MSY

Masters Energy Inc.

October 31, 2007 17:04 ET

Masters Energy Inc. Reports Third Quarter 2007 Interim Results

CALGARY, ALBERTA--(Marketwire - Oct. 31, 2007) - Masters Energy Inc. (TSX:MSY) ("Masters" or the "Company") is pleased to report financial and operating results for the three and nine month periods ended September 30, 2007.

Several significant accomplishments were achieved during the period;

- The results of the Little Bow core flood study, conducted by an independent engineering firm, indicate that implementation of an alkaline-surfactant-polymer ("ASP") chemical flood would recover incremental reserves of 15 to 20 percent of original oil in place (approximately 4.0 to 5.3 million barrels net to Masters)

- Acquired minor working interests at Little Bow for $0.9 million adding 380,000 boe of proved and probable reserves

- Expanded bank line from $22 million to $28 million

- Increased undeveloped land acreage by 26,600 acres

- Increased third quarter production 10 percent over first quarter 2007 and 23 percent over third quarter 2006



Three Months Nine Months
Ended Ended
September 30, September 30,
HIGHLIGHTS 2007 2006 2007 2006
----------------------------------------------------------------------------
(Unaudited)
Financial ($ thousands,
except per share amounts)
Gross revenue 6,823 5,971 19,819 18,304

Funds generated by operations 3,226 3,144 8,980 9,238
Per share - basic 0.21 0.20 0.58 0.61
- diluted 0.21 0.20 0.57 0.58

Net earnings 267 815 726 1,832
Per share - basic 0.02 0.05 0.05 0.12
- diluted 0.02 0.05 0.05 0.12

Exploration and development
capital expenditures 2,863 5,625 9,496 18,468

Working capital deficiency 1,342 1,904 1,342 1,904

Long-term debt 20,300 14,467 20,300 14,467

Operations
Production
Crude oil (bbls/d) 787 791 763 795
NGL (bbls/d) 13 10 12 10
Natural gas (mcf/d) 4,698 2,897 4,559 3,439
Total production (boe/d at 6:1) 1,583 1,284 1,535 1,379

Average sales price
Crude oil ($/bbl) 54.41 58.03 50.52 52.42
NGL ($/bbl) 63.02 62.72 60.04 60.69
Natural gas ($/mcf) 6.07 5.61 6.86 6.38


President's Message to the Shareholders

During the third quarter of 2007 Masters spent $2.9 million on capital projects. Field activity included drilling a successful gas well in Southern Alberta and recompleting several gas wells in the North Peace River Arch area. Production volumes increased slightly over the second quarter of 2007, however, the production was less than anticipated because the Little Bow field was slow to return to its original production levels after being temporarily shut in for several days in June due to a scheduled plant turnaround at a third party facility. Current production is approximately 1,600 boe per day and is expected to increase to 1,700 boe per day in early November following the tie-in of a natural gas well at Enchant.

The Company has taken advantage of the lower prices at Crown land sales to increase its prospect inventory. Field costs and availability of services have improved significantly and we believe this is an attractive environment to exploit our prospect inventory. We expect to drill eight to ten exploration wells during the remainder of 2007 and the first quarter of 2008. Five of the wells are high impact exploration wells.

The Company's cash flow has been relatively stable over the past several months. Natural gas prices have declined recently but oil prices have been strong. Masters production is split evenly between oil and natural gas resulting in relatively stable netbacks and cash flow. We expect crude oil prices to remain strong and natural gas prices to be weak in the short to medium term.

Little Bow Enhanced Oil Recovery Project Update

Masters continues to proceed toward implementing an ASP flood at the Company's property at Little Bow. In June 2007, Masters announced it had contracted an engineering consulting firm, specializing in enhanced oil recovery, to evaluate the Company's oil producing property at Little Bow. The oil pool has produced for a total of 30 years and has been under waterflood for 25 of those years. The Company currently produces approximately 700 barrels per day of crude oil at Little Bow.

The ASP flood is designed to decrease interfacial tension and improve the vertical sweep efficiency, resulting in a higher ultimate oil recovery than would be achieved with the existing waterflood. Analogous oil reservoirs have experienced incremental oil recoveries between 12 and 25 percent of original oil in place. The core studies indicate that an ASP flood would significantly enhance the recovery of oil at Little Bow.

Based on the results of the third and final phase of core work, an incremental 15 to 20 percent of the original oil in place is expected to be recovered by implementing an ASP flood. Production modeling performed by the enhanced oil recovery consultant forecasts that oil production, net to Masters, could increase from the current rate of 700 barrels per day to approximately 4,000 to 5,100 barrels per day at a 15 percent and 20 percent recovery factor, respectively. McDaniel and Associates, an independent reserves evaluator, estimates that the Little Bow pool has 34 million barrels of original oil in place, of which, approximately 31 percent has been recovered to date. Incremental recoverable reserves, net to Masters, could potentially be 4.0 to 5.3 million barrels (15 to 20 percent recovery factor) by implementing the ASP flood.

Further detailed engineering design and reservoir simulation studies are currently being carried out before construction of the ASP facility begins. We expect to be able to determine the total cost of the project, including the cost of the facilities, field infrastructure and injection chemicals, by year-end. The estimated time for the ASP facility construction and installation is approximately six months. Initial production response from the ASP injection is estimated to occur within three months and peak production is anticipated to occur two to three years after ASP injection commences.

An application to carry out the enhanced oil recovery program at Little Bow is expected to be submitted to the AEUB subsequent to completing the engineering work currently underway.

Outlook

The strategy for the remainder of 2007 and the early part of 2008 is to; continue to finalize the details pertinent to implementing the ASP flood at Little Bow, expand our prospect inventory and drill several high impact exploration plays. We intend to finance our exploration and development drilling activity primarily with cash flow. We continue to believe that the trading price of Masters' common shares does not accurately reflect the underlying value of the asset base and the Company has been purchasing shares utilizing the normal course issuer bid facility that is currently in place. We intend to continue with share purchases when applicable. We expect opportunities for acquisitions will continue to be available and we will pursue acquisitions that fit strategically and have the potential to add shareholder value.

The Alberta Government has recently announced changes to the royalty structure that will have an impact on Masters. The changes, which come into effect January 1, 2009, will increase Crown royalties paid and reduce cash flow. If the changes were enacted, based on the Company's interpretation of the publicly available information, Masters estimates that cash flow will be reduced by approximately 12 percent (based on a wellhead price for medium gravity crude oil of $55.00 CDN per barrel and a natural gas price of $7.00 per gigajoule) at current well production rates. Currently, the Company receives an estimated average wellhead price of $60.00 CDN per barrel. The royalty changes would also reduce the net present value (discount rate of 10%) of the ASP project by approximately 11 percent, assuming a constant wellhead price of $55.00 CDN per barrel.

The Company plans to drill eight to ten wells during the remainder of 2007 and into the first quarter of 2008. Five of the wells are high impact exploration wells which, if successful, could have a significant impact on the Company. We estimate we will exit the year at 1,700 boe per day.

The current business environment for the oil and gas sector remains attractive. Although short-term gas prices are weak, crude prices have experienced record highs, interest rates remain low and demand for energy remains high. In addition, capital costs associated with exploration and development such as land costs and field services/supplies has decreased noticeably.

We continue to be optimistic about the future. We are particularly excited about the enhanced oil recovery project at Little Bow and the high impact prospects we intend to drill in the next four to five months. We look forward to sharing the results in the near future.



On behalf of the Board of Directors,

Geoff C. Merritt
President and Chief Executive Officer
October 31, 2007


MANAGEMENT'S DISCUSSION AND ANALYSIS

ADVISORIES

Management's discussion and analysis ("MD&A") of Masters Energy Inc. ("Masters or the Company"), provided as of October 31, 2007, should be read in conjunction with the unaudited financial statements presented for the three and nine months ended September 30, 2007 and 2006 and the audited financial statements and related notes for the years ended December 31, 2006 and 2005.

Basis of Presentation - The financial data presented below has been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). The reporting and the measurement currency is the Canadian dollar.

Non-GAAP Measurements - The MD&A contains the terms 'funds generated by operations' and 'funds generated by operations per share', which should not be considered an alternative to, or more meaningful than net earnings or cash flow from operating activities as determined in accordance with GAAP as an indicator of the Company's performance. Masters' determination of funds generated by operations and funds generated by operations per share may not be comparable to that reported by other companies. Management uses funds generated by operations to analyze operating performance and leverage and considers funds generated by operations to be a key measure as it demonstrates the Company's ability to generate cash necessary to fund future capital investments and to repay debt. The reconciliation between net earnings and funds generated by operations can be found in the statements of cash flows in the financial statements. Masters presents funds generated by operations per share, which is prohibited under GAAP. Per share amounts are calculated using weighted average shares outstanding consistent with the calculation of earnings per share.

Masters uses certain industry benchmarks such as operating netback to analyze financial and operating performance. Operating netback is the net result of resource revenues less royalties and operating expenses. This benchmark as presented does not have any standardized meaning prescribed by GAAP and therefore may not be comparable with the calculation of similar measures for other entities.

Presentation of BOE - Masters bases calculations of barrels of oil equivalent ("boe") on a conversion rate of six thousand cubic feet ("mcf") of natural gas to one barrel ("bbl") of crude oil. The boe unit may be misleading, particularly if used in isolation. A boe conversion ratio of six mcf equals one bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead.

Forward-Looking Information - This MD&A contains forward looking or outlook information with regard to Masters within the meaning of applicable securities laws. Forward-looking statements may include estimates, plans, expectation, forecasts, guidance or other statements that are not statements of fact. Masters believes the expectations reflected in such forward-looking statements are reasonable. However, no assurance can be given that such expectations will prove to be correct. These statements are subject to certain risks and uncertainties and may be based on assumptions that could cause actual results to differ materially from those anticipated or implied in the forward-looking statements. These risks include but are not limited to: crude oil and natural gas price volatility, exchange rate and interest rate fluctuations, availability of services and supplies, market competition, uncertainties in the estimates of reserves, the timing of development expenditures, production levels and the timing of achieving such levels, Masters' ability to replace and expand oil and natural gas reserves, the sources and adequacy of funding for capital investments, the Company's future growth prospects and current and expected financial requirements, the cost of future reclamation and site restoration, the Masters' ability to enter into or renew leases and to secure adequate product transportation, changes in environmental and other regulations and general economic conditions. These statements speak only as of the date of this MD&A and Masters does not undertake an obligation to update our forward-looking statements except as required by law.

Alberta Royalty Review - On October 25, 2007, the Government of Alberta announced changes to the royalties payable on all Crown mineral rights owned by the province. If enacted as stated on January 1, 2009, factors that will affect the calculation of Crown royalties to be paid will include the production rate per well, commodity prices and depth of producing wells. Based on Masters' current production profile and commodity prices, future Crown royalties paid to the province of Alberta in 2009 and thereafter will increase and consequently reduce the cash flow available for future capital spending.



PRODUCTION

Three Months Nine Months
Ended Ended
September 30, September 30,
2007 2006 2007 2006
--------------------------------------
Total Production
Crude oil (bbl) 72,415 72,815 208,383 217,134
Natural gas liquids ("NGL") (bbl) 1,154 938 3,305 2,863
Natural gas (mcf) 432,173 266,511 1,244,598 938,782
Total (boe) 145,598 118,172 419,121 376,461
Daily Production
Crude oil (bbl/d) 787 791 763 795
NGL (bbl/d) 13 10 12 10
Natural gas (mcf/d) 4,698 2,897 4,559 3,439
Total (boe/d) 1,583 1,284 1,535 1,379


Production volumes for the third quarter ended September 30, 2007 averaged 1,583 boe/d, an increase of 23 percent in comparison with the third quarter of 2006. Oil and NGL production for the third quarter of 2007 remained unchanged at 800 bbl/d compared to 801 bbl/d in the same period in 2006. Natural gas production for the third quarter ended September 30, 2007 increased 62 percent to 4.7 mmcf per day from 2.9 mmcf per day for the three months ended September 30, 2006. Production increased during 2007 as a result of successful wells being drilled and tied-in since the third quarter of 2006. Year to date production for the first nine months of 2007 was 1,535 boe/d, an increase of 11 percent in comparison to the same period for 2006. Production increased as a result of successful wells being drilled or recompleted and tied-in.



PRICES

Three Months Nine Months
Ended Ended
September 30, September 30,
2007 2006 2007 2006
--------------------------------------

Crude oil ($/bbl) 54.41 58.03 50.52 52.42
--------------------------------------
--------------------------------------
NGL ($/bbl) 63.02 62.71 60.04 60.69
--------------------------------------
--------------------------------------
Natural gas ($/mcf) 6.07 5.61 6.86 6.38
--------------------------------------
--------------------------------------


West Texas Intermediate ("WTI") is the benchmark for North American oil prices and is the crude type against which NYMEX futures contracts are priced. Canadian crude oil prices are based on refiners' postings at hubs such as Edmonton and Hardisty, Alberta. The basis for Canadian postings is the WTI price at Cushing, Oklahoma minus a transportation differential, adjusted for the US/Canadian currency exchange rate and for relative quality and regional market conditions.

During the third quarter of 2007 North America saw some strengthening in the price levels for WTI crude oil primarily due to higher concerns over supply. As a result, the average price for a barrel of WTI crude during the period increased $4.74(US) to $75.22(US) from the third quarter of 2006. The Canadian dollar strengthened relative to the US dollar during the course of the year. The average currency exchange rate for $1.00 Canadian increased from $0.892(US) in the third quarter of 2006 to $0.956(US) in the similar period of 2007. As a result, this lowered the effective price received for delivery of crude expressed in Canadian dollars. The expanding quality price differential postings on medium type crudes experienced a negative effect during the third quarter of 2007. The average differential between Edmonton light sweet crude postings and Hardisty Bow River medium crude in the third quarter of 2007 increased 20 percent, to approximately $25.10 per bbl (2006 - $20.86 per bbl). The Company's crude oil field price for the third quarter of 2007 decreased six percent to $54.41 per bbl from the average price received in the third quarter of 2006 primarily due to the widening in the quality price differential and the stronger Canadian currency.

The Company's crude oil field price for the first nine months of 2007 was $50.52 per bbl, a decrease of four percent from the average price received in the first nine months of 2006 primarily due to the decrease in the average year to date 2007 WTI posting of $66.22(US) per bbl (2006 - $68.15(US)) and the stronger Canadian currency.

US natural gas prices are typically referenced off NYMEX at Henry Hub, Louisiana while Canadian prices are referenced at Nova Inventory Transfer ("NIT") or the AECO Hub. Most of Masters' natural gas is sold to the spot market according to the AECO reference price.

During the early portion of 2006, North America experienced some of the warmest weather on record causing the demand for natural gas to be down from historic winter levels. This resulted in record levels for natural gas supply in storage in the United States and Canada at the end of the withdrawal season. Storage levels at the end of the first quarter of 2006 were approximately 60 percent above the five-year averages. As a result of this large storage overhang, 2006 natural gas prices were weaker than the previous year.

During the 2006 - 2007 winter, North America experienced normal weather conditions causing the demand for natural gas to return to historic winter levels. Storage levels at the end of the second quarter 2007 were within the five-year averages. However, since that time the natural gas storage levels for 2007 have returned to the same levels as 2006.

The outlook for natural gas prices in the short term is somewhat bearish as demand for natural gas in the United States ("US") remains static and supply is expanding with higher levels of US drilling directed at natural gas prospects and increased import deliveries of Liquefied Natural Gas into the US. Weather is a key component for the demand of natural gas within North America. This is largely driven by natural gas consumed in the summer to generate electricity for air conditioning and for heating in the winter. The medium to longer term outlook for natural gas prices remains positive.

The average natural gas price received during the third quarter of 2007 was $6.07 per mcf, an increase of eight percent from the price received in the same period of 2006. During the third quarter 2007 the Company realized a gain of $0.3 million from the fixed price financial commodity contract. The commodity contract increased the average natural gas price received by $0.71 per mcf. The average natural gas price received for the first nine months of 2007 was $6.86 per mcf, an increase of eight percent from the average price received in the first nine months of 2006. For the nine months ended September 30, 2007, the Company realized a gain of $0.4 million from the fixed price commodity contract which increased the average price received by $0.31 per mcf.

Masters' management complies with a Risk Management Policy approved by the Board of Directors. The objective of Masters' risk management activities is to reduce exposure to decreases in commodity prices that would materially impact funds generated by operating activities and, ultimately, reduce capital spending which generates Masters' growth. Any transactions entered into would involve credit worthy purchasers and would be for less than one year. To ensure Masters has sufficient physical volumes available to meet the obligations of such transactions, Masters limits the volumes contracted to no more than 50 percent of forecasted production after royalties.



For 2007 Masters has entered into a fixed price financial contract as
follows which was outstanding at September 30, 2007;

Daily
Notional
Product Index Term Volume Price Received
----------------------------------------------------------------------------
Gas Fixed AECO-C Apr. 1/07 - Oct. 31/07 1,500 GJ $7.54 per GJ

Masters did not enter into any fixed or hedged type gas sales contracts
during the nine month period ending September 30, 2006.

REVENUES

Three Months Nine Months
Ended Ended
September 30, September 30,
($ thousands, except as indicated) 2007 2006 2007 2006
----------------------------------------------------------------------------
Crude oil revenue 3,941 4,226 10,529 11,382
NGL revenue 73 59 198 174
Natural gas revenue 2,622 1,496 8,532 5,994
----------------------------------
Total petroleum and natural gas revenue 6,636 5,781 19,259 17,550
Royalty revenue 187 190 560 754
----------------------------------
Total resource revenue 6,823 5,971 19,819 18,304
----------------------------------
----------------------------------
Total petroleum and natural
gas revenue per boe ($) 45.57 48.92 45.95 46.62
----------------------------------
----------------------------------
Total resource revenue per boe ($) 46.86 50.52 47.29 48.62
----------------------------------
----------------------------------


Petroleum and natural gas revenues for the third quarter of 2007 increased 15 percent to $6.6 million from the similar period in 2006 due to higher natural gas prices and production volumes. The petroleum and natural gas revenues for the first nine months of 2007 was $19.3 million, an increase of 10 percent over the same period of 2006.

Royalty and other income for the third quarter of 2007 decreased by two percent to $0.2 million. Similarly, the royalty and other revenue for the first nine months of 2007 was $0.6 million, a decrease of 25 percent as a result of disposing non-core royalty interests in September 2006.



ROYALTIES

Three Months Nine Months
Ended Ended
September 30, September 30,
($ thousands, except as indicated) 2007 2006 2007 2006
----------------------------------------------------------------------------
Crown 1,328 835 3,639 3,238
ARTC - (125) - (375)
----------------------------------
Crown, net of ARTC 1,328 710 3,639 2,863
Freehold and gross overriding 93 17 354 384
----------------------------------
Net royalties 1,421 727 3,993 3,247
----------------------------------
----------------------------------
Per boe ($) 9.76 6.15 9.53 8.63
----------------------------------
----------------------------------
Average royalty rate - net (%)(1) 21.4 12.8 20.7 18.5
----------------------------------
----------------------------------

(1) A percentage of total petroleum and natural gas revenue


For the three months ended September 30, 2007, net royalties totaled $1.4 million for an average royalty rate relative to oil and gas revenues of 21.4 percent. The increase in the net average royalty rate is a result of royalty incentives expiring on reactivated wells in the Little Bow field and the termination of the ARTC program at the beginning of 2007. On a boe basis, royalties for the period were $9.76 per boe. For the similar period in 2006 the net royalty rate averaged 12.8 percent of oil and gas revenues or $6.15 per boe.

For the nine months ended September 30, 2007, royalties totaled $4.0 million for an average rate of 20.7 percent or $9.53 per boe. For the comparable period in 2006 the royalty rate averaged 18.5 percent or $8.63 per boe. The ARTC program was terminated effective January 1, 2007.

UNREALIZED LOSS ON COMMODITY CONTRACT

For 2007 Masters has entered into a fixed price financial contract as follows;



Daily
Notional
Product Index Term Volume Price Received
----------------------------------------------------------------------------
Gas Fixed AECO-C Apr. 1/07 - Oct. 31/07 1,500 GJ $7.54 per GJ


An unrealized loss of $0.1 million, for the third quarter of 2007 (nil - 2006), on the commodity contract represents the change in the fair value of the contract at September 30, 2007. For the first nine months of 2007 an unrealized loss of $0.2 million (nil - 2006) was reported. The fair value of this contract is an estimate of the amount that would have been paid or received from counterparties to settle the outstanding contract at the end of the period.



OPERATING EXPENSES

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands, except as indicated) 2007 2006 2007 2006
----------------------------------------------------------------------------
Total operating expenses 1,543 1,463 4,486 3,758
----------------------------------
----------------------------------
Per boe ($) 10.59 12.38 10.70 9.98
----------------------------------
----------------------------------


Operating expenses for the three months ended September 30, 2007 was $1.54 million, an increase of five percent compared to $1.46 million during the same period in 2006 primarily as a result of higher aggregate and higher processing fees for the increased natural gas production. On a boe basis, the 2007 third quarter operating expenses decreased 14 percent to an average cost of $10.59 per boe produced from $12.38 per boe in the same period in 2006. Operating expenses of $10.70 per boe in the first nine months of 2007 have increased seven percent compared to the average boe operating expense for the similar period in 2006.

Operating expenses per boe for the balance of 2007 are anticipated to remain consistent with the year to date results.



Netback Analysis

Three Months Nine Months
Ended Ended
September 30, September 30,
($ per boe) 2007 2006 2007 2006
----------------------------------------------------------------------------
Oil and gas revenues 45.57 48.92 45.95 46.62
Royalty and other revenue 1.29 1.60 1.34 2.00
----------------------------------
46.86 50.52 47.29 48.62
Royalties, net of ARTC (9.76) (6.15) (9.53) (8.63)
Operating expenses (10.59) (12.38) (10.70) (9.98)
----------------------------------
Operating netback 26.51 31.99 27.06 30.01
----------------------------------
----------------------------------


Operating netback of $26.51 per boe for the third quarter of 2007 decreased 17 percent from the similar period in 2006 primarily as a result of lower crude prices and higher crown royalties with the elimination of the ARTC program in 2007. For the nine months ended September 30, 2007 the operating netback was $27.06 per boe, a decrease of 10 percent in comparison to the same period in 2006.



GENERAL and ADMINISTRATIVE

Three Months Nine Months
Ended Ended
September 30, September 30,
($ thousands, except as indicated) 2007 2006 2007 2006
----------------------------------------------------------------------------
Gross general and administrative 523 484 2,104 1,931
Operating recoveries (21) (33) (53) (89)
Capitalized expenses (267) (166) (762) (639)
----------------------------------
General and administrative expense,
before stock-based compensation 235 285 1,289 1,203
Stock-based compensation 75 116 266 385
Capitalized future stock-based
compensation (42) (148) (145) (148)
----------------------------------
Total general and administrative expense 268 253 1,410 1,440
----------------------------------
----------------------------------
General and administrative expense,
before stock-based compensation, per
boe ($) 1.62 2.41 3.08 3.20
----------------------------------
----------------------------------
Total general and administrative expense
per boe ($) 1.84 2.14 3.36 3.83
----------------------------------
----------------------------------


During the third quarter of 2007, total general and administrative costs increased over the third quarter 2006. Total general and administrative expense per boe decreased 14 percent in the third quarter of 2007 versus the third quarter of 2006. The year to date 2007 general administrative costs are comparable to the first nine months of 2006. The total general and administrative expense for the first three quarters of 2007 decreased 12 percent to $3.36 per boe from $3.83 per boe as result of higher production volumes.

Total general and administrative expenses for the remainder of 2007 are anticipated to be similar to 2006. Based on forecasted production and capital spending, 2007 staff levels are anticipated to be similar to 2006.



INTEREST EXPENSE

Three Months Nine Months
Ended Ended
September 30, September 30,
($ thousands except as indicated) 2007 2006 2007 2006
----------------------------------------------------------------------------
Total interest expense 315 292 908 742
----------------------------------
----------------------------------
Per boe ($) 2.16 2.47 2.17 1.97
----------------------------------
----------------------------------


Interest expense for the three months ended September 30, 2007 was $0.3 million, an increase of eight percent compared to the same period in 2006 due to higher debt levels and borrowing rates. On a boe basis, the 2007 third quarter interest expenses decreased 13 percent to an average cost of $2.16 per boe produced from $2.47 per boe in the same period in 2006. For the year to date period to September 30, 2007, interest expense increased 22 percent to $0.9 million in comparison to the similar period in 2006.



DEPLETION, DEPRECIATION and ACCRETION

Three Months Nine Months
Ended Ended
September 30, September 30,
($ thousands except as indicated) 2007 2006 2007 2006
----------------------------------------------------------------------------
Depletion 2,743 1,998 7,761 6,797
Depreciation 2 3 6 8
Accretion on asset retirement obligations 31 32 92 93
----------------------------------
Total depletion, depreciation and
accretion expense 2,776 2,033 7,859 6,898
----------------------------------
----------------------------------
Depletion, depreciation and accretion
expense per boe ($) 19.07 17.20 18.75 18.32
----------------------------------
----------------------------------


For the third quarter of 2007, depletion, depreciation and accretion expense increased 37 percent to $2.8 million from $2.0 million for the same period in 2006. The increase is due to higher production and higher depletion rate. During the third quarter of 2006 a non core royalty interest, which had no associated reserve volumes, was sold and the proceeds on the sale reduced the depletion rate. On a boe basis depletion, depreciation and accretion for the third quarter of September 2007 increased 11 percent to $19.07 from $17.20 in the same period in 2006.

For the nine months ended September 30, 2007, depletion, depreciation and accretion expense increased 14 percent to $7.9 million from $6.9 million for the same period in 2006. For the first nine months of 2007, depletion, depreciation and accretion expense per boe increased two percent to $18.75 per boe.

At September 30, 2007, the ceiling test calculation confirmed that the estimated undiscounted future cash flows from proven reserves exceeded the carrying values of producing petroleum and natural gas properties and therefore a ceiling test impairment does not exist.



INCOME TAXES

Three Months Nine Months
Ended Ended
September 30, September 30,
($ thousands, except as indicated) 2007 2006 2007 2006
----------------------------------------------------------------------------
Future income taxes 119 382 224 387
----------------------------------
----------------------------------
Effective tax rate (%) 30.8 31.9 23.5 17.4
----------------------------------
----------------------------------


The future income tax provision for the three months ended September 30, 2007 is $0.1 million, a decrease of 69 percent from the third quarter of 2006. For the nine months ended September 30, 2007 the future tax provision decreased to $0.2 million from $0.4 million in the comparable period in 2006. The decrease in 2007 future tax expense is primarily due to lower earnings before taxes.

As at September 30, 2007, the Company has approximately $49.4 million in tax pools to shelter taxable income in future years.

CASH FLOW FROM OPERATIONS and NET EARNINGS

Funds generated by operations increased three percent to $3.2 million for the three months ended September 30, 2007 compared to $3.1 million during the same period in 2006. For the first nine months of 2007, funds generated by operations decreased three percent to $9.0 million compared to $9.2 million during the first nine months of 2006. The decrease is primarily due to lower crude prices received and higher crown royalty expense with the elimination of the ARTC program in 2007.

Net earnings were $0.3 million for the three months ended September 30, 2007 compared to net earnings of $0.8 million during the same period in 2006. Net earnings per basic and diluted share for the quarter was $0.02 compared to net earnings of $0.05 per basic and diluted share during the same quarter in 2006.

For the nine months ended September 30, 2007, net earnings decreased 60 percent to $0.7 million compared to $1.8 million during the comparable period in 2006. The decrease is a result of higher depletion, depreciation and accretion expense. Net earnings per basic and diluted share for the nine month period was $0.05 compared to $0.12 per basic and diluted share during the same period in 2006.

CAPITAL EXPENDITURES

During the first nine months of 2007 the Company spent approximately $9.5 million in exploration and development capital expenditures compared to $18.5 million spent in the same period of 2006. For the nine months ended September 30, 2007, the Company drilled or recompleted 17 wells (13.0 net) with a success rate of 59 percent, added 26,600 net undeveloped acres and acquired 120 kilometers of 2-D and 7 square kilometers of 3-D seismic during the period. During the second quarter of 2007, the Company acquired minor working interests in the Little Bow pool for a cost of $0.9 million and disposed a minor non-core property in the North Peace River Arch area for proceeds of $0.3 million.



Three Months Nine Months
Ended Ended
September 30, September 30,
($ thousands) 2007 2006 2007 2006
----------------------------------------------------------------------------
Land 560 234 1,741 1,450
Geological and geophysical 237 406 988 2,946
Drilling and completions 1,488 4,081 4,297 9,306
Equipping and facilities 578 904 2,470 4,766
----------------------------------
Total exploration and development capital 2,863 5,625 9,496 18,468
Producing property acquisition - - 882 -
Disposal of property - (6,200) (265) (6,200)
----------------------------------

Total capital expenditures 2,863 (575) 10,113 12,268
----------------------------------
----------------------------------

Drilling/Recompletion Results

During the third quarter of 2007 the Company drilled and recompleted six
wells resulting in four natural gas wells for a success rate of 67 percent.

Three Months Nine Months Nine Months
Ended Ended Ended
September 30, September 30, September 30,
2007 2007 2006
(wells) Gross Net Gross Net Gross Net
----------------------------------------------------------------------------

Oil - - 4 4.0 - -
Natural Gas 4 2.3 6 3.3 13 5.1
Dry 2 1.8 7 5.7 13 6.6
------------------------------------------
Total 6 4.1 17 13.0 26 11.7
------------------------------------------
------------------------------------------
Success rate (%) 67 56 59 56 50 44
------------------------------------------
------------------------------------------


CONTRACTUAL OBLIGATIONS

On April 18, 2006, the Company completed the issuance of 1,000,000 flow-through common shares for total proceeds of $6.1 million. The proceeds from the share issuance are to be spent on qualified exploration expenditures prior to December 31, 2007. As at September 30, 2007, the funds were spent and no further exploration expenditure obligations remained outstanding.

There have been no significant contract changes from the December 31, 2006 year-end.

LIQUIDITY and CAPITAL RESOURCES

The Company's total capitalization at September 30, 2007 was $63.3 million with the market value of common shares representing 53 percent of total capitalization. Net debt represented 34 percent and asset retirement obligations and future income taxes accounted for 13 percent.



Total Market Capitalization
($ thousands except as indicated) 2007 %
----------------------------------------------------------------------------
Common shares outstanding (thousands) 15,424
Share price, September 30, 2007 ($ per share) 2.18
-------------------
Total market capitalization 33,624 53
-------------------
Working capital deficiency 1,342
Bank debt 20,300
-------------------
Net debt 21,642 34
-------------------
Asset retirement obligation 3,665 6
Future income taxes 4,356 7
-------------------
Total capitalization 63,287 100
-------------------
-------------------
Net debt to total capitalization 34%
-------------------
-------------------


Masters has a bank revolving term facility of $28.0 million to fund future activities which was established September 2007. The facility is a borrowing base facility determined by Masters' latest reserves assessment, results of operations, current and forecasted commodity prices and the prevailing economic market. The next review of the bank revolving term facility is April 2008. At September 30, 2007 the Company had borrowed approximately $20.3 million and had a working capital deficit of $1.3 million totaling $21.6 million of total net debt.

The Company's future investing activities, which consist primarily of capital expenditures on oil and gas activities, will be funded with working capital, funds generated by operations and bank debt.

In November 2006, Masters announced a normal course issuer bid which is in effect for one year. During the first nine months ended September 30, 2007, the Company purchased 116,000 common shares for total consideration of $316,000. Since the commencement of the normal course issuer bid the Company has purchased 146,000 common shares for total consideration of $418,000.

As at September 30, 2007 the issued and outstanding common shares of the Company were 15,423,979, options outstanding were 1,510,000 and performance warrants outstanding of 885,000.

CHANGES IN ACCOUNTING POLICIES

Effective January 1, 2007, the Company adopted the following new CICA standards regarding financial instruments;

a. CICA handbook section 3855 "Financial Instruments - Recognition and Measurement",

b. CICA handbook section 3861 "Financial Instruments - Disclosure and Presentation",

c. CICA handbook section 1530 "Comprehensive Income", and

d. CICA handbook section 3865 "Hedges".

The standards require inclusion of all financial instruments other than held-to-maturity investments, loans and receivables, on a company's balance sheet at their fair value. Held-to-maturity investments, loans and receivables would be measured at their amortized cost. The standards create a new statement of comprehensive income, which is defined as a change in equity, that will include changes in fair value of certain derivative financial instruments. The Company elects to mark-to-market its derivative contracts under its risk management program. The accounting for hedging relationships for prior fiscal years is not retroactively changed. Therefore, management expects no restatement of prior periods is expected as a result of these new standards.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

During the most recent interim period, there have been no changes in Masters' policies and procedures and other processes that comprise its internal controls over financial reporting, that have materially affected, or are reasonably likely to materially affect, Masters' control over financial reporting. For further discussion of internal controls over financial reporting refer to Masters' 2006 Annual Report.

SELECTED QUARTERLY INFORMATION

The financial data presented below has been prepared in accordance with Canadian generally accepted accounting principles. The reporting and measurement currency is the Canadian dollar.



2007
------
Operations Q3 Q2 Q1
----------- --------- --------- ---------
Production
Oil (bbl/d) 787 768 734
NGL (bbl/d) 13 16 8
Natural gas (mcf/d) 4,698 4,758 4,216
Total (boe/d) 1,583 1,576 1,445
Pricing
Oil ($/bbl) 54.41 49.08 47.78
NGL ($/bbl) 63.02 60.02 55.43
Natural gas ($/mcf) 6.07 7.27 7.28
Total ($/boe) 45.57 46.44 45.83
Financial
----------
($ thousands, except as indicated)
Total revenue 6,823 6,889 6,108
Funds generated by operations 3,226 3,111 2,643
Net earnings (loss) 267 553 (94)
Per share - basic 0.02 0.04 (0.01)
Per share - diluted 0.02 0.04 (0.01)
Capital spending
Exploration and development 2,863 2,998 3,634
Acquisitions/(dispositions) - 617 -
Total assets 70,440 70,361 69,586
Working capital deficiency 1,342 1,062 1,990
Long-term debt 20,300 20,741 19,550
Shareholders' equity 38,805 38,552 37,910
Common Shares
--------------
Weighted average common shares outstanding
(thousands)
- basic 15,449 15,460 15,506
- diluted 15,586 15,745 15,717
Trading Activity
Volume (thousands)
- total 696 1,255 2,337
- daily 11 20 37
Price ($ per share)
- high 3.14 3.22 3.40
- low 2.08 2.72 2.41
- closing 2.18 3.08 2.89


2006 2005
------ ------
Operations Q4 Q3 Q2 Q1 Q4
----------- --------- --------- --------- --------- ---------
Production
Oil (bbl/d) 749 791 781 813 707
NGL (bbl/d) 10 10 13 9 10
Natural gas (mcf/d) 4,417 2,897 3,543 3,888 3,619
Total (boe/d) 1,495 1,284 1,384 1,470 1,320
Pricing
Oil ($/bbl) 42.31 58.03 59.65 39.82 42.50
NGL ($/bbl) 71.65 62.71 61.62 56.87 60.85
Natural gas ($/mcf) 7.07 5.61 5.91 7.41 11.29
Total ($/boe) 42.57 48.92 49.34 41.97 54.18
Financial
----------
($ thousands, except
indicated)
Total revenue 5,960 5,971 6,545 5,788 6,908
Funds generated by
operations 2,200 3,144 3,553 2,542 2,915
Net earnings (loss) 26 815 800 217 630
Per share - basic 0.00 0.05 0.05 0.02 0.04
Per share - diluted 0.00 0.05 0.05 0.01 0.04
Capital spending
Exploration and development 6,022 5,625 4,487 8,355 11,570
Acquisitions/(dispositions) - (6,200) - - 31
Total assets 70,275 65,176 66,533 64,228 60,016
Working capital deficiency 2,156 1,904 1,496 7,477 5,013
Long-term debt 17,824 14,467 18,584 17,442 14,093
Shareholders' equity 39,921 39,861 38,940 32,064 31,791
Common Shares
--------------
Weighted average common
shares outstanding
(thousands)
- basic 15,559 15,570 15,356 14,523 14,491
- diluted 15,974 16,093 16,052 15,433 15,482
Trading Activity
Volume (thousands)
- total 865 773 804 1,757 2,351
- daily 14 12 13 27 38
Price ($ per share)
- high 4.08 4.28 5.39 6.75 6.95
- low 3.00 3.25 3.56 4.25 4.60
- closing 3.40 3.35 3.80 4.89 6.47


Factors that caused variations over the quarters -

- The Company completed four acquisitions since its initial financing in the fourth quarter of 2003 which have impacted production growth:

-- The acquisition of the Little Bow property in Southern Alberta on December 22, 2003 added approximately 450 boe per day consisting of approximately 90 percent crude oil production. Proved and probable reserves acquired were approximately 1.4 million boe with an estimated reserve life index of 8.6 years.

-- The acquisition of Terraquest Energy Corporation on February 26, 2004 added production of approximately 400 boe per day consisting of approximately 60 percent natural gas. Proved and probable reserves acquired were approximately 1.1 million boe with an estimated reserve life index of 7.9 years based on the production at the time of acquisition.

-- The two acquisitions of producing properties in the Peace River Arch area of Northwest Alberta on September 3, 2005 and September 12, 2005 added approximately 160 boe per day consisting primarily of natural gas production. Proved and probable reserves acquired were approximately 0.5 million boe with an estimated reserve life index of 7.0 years.

- Production growth, other than the acquisitions is a result of Masters' exploration and development activities. Timing of production is subject to timing of drilling and facility construction.

- Growth in revenue and funds generated by operations is the combination of increased production and strong commodity prices. Oil prices for medium grade quality crude experienced a large drop in the latter portion of the fourth quarter 2004 due to wider than historical quality differentials. This impacted the prices received by Masters since that time as a majority of the crude production is of medium quality. During the first quarter of 2007 the price quality differentials for medium gravity crudes returned to historical levels.

- The net earnings are impacted by depletion, depreciation, accretion and future income taxes. The Company estimates its reserves every quarter based on its acquisition and drilling activities. The annual reserves are determined by independent reservoir evaluators, the results of which can affect fourth quarter reserve additions. Enacted changes to the federal and provincial income tax rates for the oil and gas industry impact future income taxes.

- The development of future drilling prospects and seasonal field conditions influence capital spending. Funds generated by operations, bank debt and the issuance of common shares primarily funded capital spending.



Masters Energy Inc.
Balance Sheets
(unaudited)
----------------------------------------------------------------------------
($ thousands)
As at As at
September 30, December 31,
2007 2006
----------- ------------
Assets

Current assets
Accounts receivable $ 1,666 $ 4,283
Prepaid expenses and deposits 306 281
----------- ------------
1,972 4,564

Property and equipment (note 2) 68,468 65,711
----------- ------------
$ 70,440 $ 70,275
----------- ------------
----------- ------------
Liabilities
Current liabilities
Accounts payable and accrued liabilities $ 3,314 $ 6,720
Long-term bank debt (note 3) 20,300 17,824
Asset retirement obligations (note 4) 3,665 3,527
Future income taxes (note 8) 4,356 2,283
----------- ------------
31,635 30,354
----------- ------------
Shareholders' Equity
Share capital (note 5) 31,263 33,314
Contributed surplus (note 6) 1,029 820
Retained earnings 6,513 5,787
----------- ------------
38,805 39,921
----------- ------------
$ 70,440 $ 70,275
----------- ------------
----------- ------------
See accompanying notes to the financial statements.



Masters Energy Inc.
Statements of Earnings, Comprehensive Income and Retained Earnings
(unaudited)
----------------------------------------------------------------------------
($ thousands except share and per share amounts)

Three months ended Three months ended
September 30 September 30
2007 2006 2007 2006
----------- ----------- ----------- -----------
Revenue
Petroleum and natural
gas revenue $ 6,636 $ 5,781 $ 19,259 $ 17,550
Royalty and other
revenue 187 190 560 754
----------- ----------- ----------- -----------
6,823 5,971 19,819 18,304
Royalties, net of
Alberta Royalty Tax
Credit (1,421) (733) (3,993) (3,247)
----------- ----------- ----------- -----------
5,402 5,238 15,826 15,057
Unrealized loss on
commodity contract
(note 9) (114) - (213) -
----------- ----------- ----------- -----------
5,288 5,238 15,613 15,057
----------- ----------- ----------- -----------
Expenses
Operating 1,543 1,463 4,486 3,758
General and
administrative 268 253 1,410 1,440
Interest 315 292 908 742
Depletion, depreciation
and accretion 2,776 2,033 7,859 6,898
----------- ----------- ----------- -----------
4,902 4,041 14,663 12,838
----------- ----------- ----------- -----------
Earnings before taxes 386 1,197 950 2,219

Future tax expense
(note 8) 119 382 224 387
----------- ----------- ----------- -----------

Net earnings and
comprehensive income 267 815 726 1,832

Retained earnings,
beginning of period 6,246 4,946 5,787 3,929
----------- ----------- ----------- -----------

Retained earnings, end
of period $ 6,513 $ 5,761 $ 6,513 $ 5,761
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------

Earnings per share
(note 7)
Basic $ 0.02 $ 0.05 $ 0.05 $ 0.12
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted $ 0.02 $ 0.05 $ 0.05 $ 0.12
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Weighted average number
of shares outstanding
(note 7)
Basic 15,449,341 15,569,979 15,468,232 15,153,520
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Diluted 15,586,428 16,093,055 15,682,883 15,859,114
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------

See accompanying notes to the financial statements.



Masters Energy Inc.
Statements of Cash Flows
(unaudited)
----------------------------------------------------------------------------
($ thousands)

Three months ended Nine months ended
September 30, September 30,
2007 2006 2007 2006
-------- -------- -------- --------
Operating activities
Net earnings $ 267 $ 815 $ 726 $ 1,832
Add (deduct) non-cash items
Depletion, depreciation and
accretion 2,776 2,033 7,859 6,898
Future income tax expense 119 382 224 387
Unrealized loss on commodity
contract 114 - 213 -
Stock-based compensation expense 33 (32) 121 237
Settlement of performance warrants - - - (52)
Settlement of asset retirement costs
(note 4) (83) (54) (163) (64)
-------- -------- -------- --------

3,226 3,144 8,980 9,238
Changes in non-cash working capital 69 635 (2,333) (3,325)
-------- -------- -------- --------
3,295 3,779 6,647 5,913
-------- -------- -------- --------
Financing activities
Long-term bank debt (441) (4,117) 2,476 374
Proceeds on flow-through share issue - - - 6,100
Proceeds on exercise of options - - - 99
Share issuance fees - (9) - (434)
Purchase of shares for cancellation
(note 5) (89) - (316) -
-------- -------- -------- --------

(530) (4,126) 2,160 6,139
-------- -------- -------- --------
Investing activities
Property and equipment (2,863) (5,625) (9,496) (18,468)
Property acquisition - - (882) -
Property disposition - 6,200 265 6,200
-------- -------- -------- --------
(2,863) 575 (10,113) (12,268)
Changes in non-cash working capital 98 (228) 1,306 216
-------- -------- -------- --------

(2,765) 347 (8,807) (12,052)
-------- -------- -------- --------
Change in cash and cash equivalents - - - -
Cash and cash equivalents, beginning
of period - - - -
-------- -------- -------- --------

Cash and cash equivalents,
end of period $ - $ - $ - $ -
-------- -------- -------- --------
-------- -------- -------- --------

Supplemental cash flow information
----------------------------------

Interest income received $ 3 $ 1 $ 3 $ 1
Interest paid $ 315 $ 292 $ 908 $ 742
Capital taxes paid $ - $ - $ - $ 2

----------------------------------------------------------------------------

See accompanying notes to the financial statements.



Masters Energy Inc.
Notes to the Financial Statements
----------------------------------------------------------------------------
(Unaudited)


1. Accounting Policies

The Masters Energy Inc. ("Masters" or "the Company") is engaged in the exploration, development and production of petroleum and natural gas in Western Canada. The financial statements are stated in Canadian dollars and have been prepared in accordance with Canadian generally accepted accounting principles.

The disclosures provided below are incremental to those included with the annual financial statements. These interim financial statements should be read in conjunction with the financial statements and notes disclosed in the Company's annual report for the year ended December 31, 2006. The interim financial statements of Masters have been prepared following the same accounting policies and methods of computation as the financial statements of the Company for the year ended December 31, 2006, except for the following changes in accounting policies:

(a) Financial instruments

On January 1, 2007 Masters adopted the new accounting standards regarding the recognition, measurement, disclosure and presentation of financial instruments. The financial instruments must be classified into one of these five categories: held-for-trading, held-to-maturity, loans and receivables, available-for-sale financial assets or other financial liabilities. The new standard requires all financial instruments within its scope, including all derivatives, to be recognized on the balance sheet initially at fair market value. Subsequent measurement of all financial assets and liabilities except those held-for-trading and available for sale are measured at amortized cost determined using the effective interest rate method. Held-for-trading financial assets are measured at fair value with changes in fair value recognized in earnings. Available-for-sale financial assets are measured at fair value with changes in fair value recognized in comprehensive income until the investment is derecognized or impaired at which time the amounts would be recorded in net earnings. In conjunction with the adoption of these new standards, the Company elected not to use hedge accounting for its natural gas derivative contract under its risk management program. The fair value of the commodity contract is recognized at each reporting period with the change in fair value being classified as an unrealized gain or loss on the statement of earnings. The impact in fair value is disclosed in note 9.

On adoption of the new standards, the Company elected to recognize, as separate assets and liabilities, only for those embedded derivatives in hybrid instruments issued, acquired or substantially modified after January 1, 2003. The Company did not identify any material embedded derivatives, which required separate recognition and measurement.

The new standards require a new statement of comprehensive income, which is comprised of net earnings and other comprehensive income which may report the changes in fair value in, derivatives designated as cash flow hedges and available-for-sale investments and foreign currency translation. The Company had no "other comprehensive income or loss" transactions during the three months ended September 30, 2007 and no opening or closing balances for the accumulated other comprehensive income or loss.



2. Property and Equipment

($ thousands) Accumulated
Depletion
and Net Book
As at September 30, 2007 Cost Depreciation Value
------------------------- ------ -------------- ----------

Petroleum and natural gas
properties and well equipment $ 96,280 $ 27,841 $ 68,439
Office equipment 73 44 29
---------- ---------- ----------

$ 96,353 $ 27,885 $ 68,468
---------- ---------- ----------
---------- ---------- ----------

As at December 31, 2006
------------------------

Petroleum and natural gas
properties and well equipment $ 85,756 $ 20,080 $ 65,676
Office equipment 73 38 35
---------- ---------- ----------

$ 85,829 $ 20,118 $ 65,711
---------- ---------- ----------
---------- ---------- ----------


The value of undeveloped lands excluded from costs subject to depletion was $9.2 million at September 30, 2007 ($7.6 million - December 31, 2006).

During the nine months ended September 30, 2007, $0.9 million ($0.8 million - September 30, 2006) of general and administrative costs were capitalized.

3. Long-term Bank Debt

The Company has access to a revolving term credit facility with a Canadian commercial bank to a maximum of $28.0 million. The credit facility may be drawn with direct advances or guaranteed notes. Direct advances bear interest at the bank's prime lending rate and the guaranteed notes bear interest at the applicable bankers' acceptance rate plus a stamping fee.

The revolving term credit facility is available until April 30, 2008. Up to 60 days prior to April 30, 2008 the Company may request an extension of the revolving facility for a period of another 364 days, subject to the bank's approval. If the Company does not request the extension or the bank does not agree to the extension, the credit facility principal borrowed will be repaid in full with a single payment one year subsequent to April 30, 2008. The nature of the lending facility is such that it is recognized as a long-term liability.

As of September 30, 2007, $20.3 million ($17.8 million - December 31, 2006) has been drawn against the revolving credit facility.

Security pledged for the facilities consists of a general assignment of book debts secured by a first floating charge over all the assets of the Company.



4. Asset Retirement Obligations

The following table summarizes changes in the asset retirement obligation
for the periods ended as indicated:

Nine Months
Ended Year Ended
September 30, December 31,
($ thousands) 2007 2006
----------------------------------------------------------------------------

Asset retirement obligation, beginning of period $ 3,527 $ 3,316
Adjustments - (122)
Liabilities incurred 209 301
Asset retirement expenditures (163) (98)
Accretion expense 92 130
----------- -----------

Asset retirement obligation, end of period $ 3,665 $ 3,527
----------- -----------
----------- -----------


The total estimated, undiscounted cash flows required to settle the obligations, before considering salvage, is $5.1 million as at September 30, 2007 ($4.9 million - December 31, 2006) which has been discounted using a weighted average credit-adjusted risk-free interest rate of 6.0 percent. The Company expects these obligations to be settled in approximately 1 to 14 years.



5. Share Capital

(a) Authorized

Unlimited number of voting common shares without nominal or par value.

Unlimited number of preferred shares issuable in series, with rights and
privileges to be determined at the time of issuance by the Board of
Directors.

(b) Issued

($ thousands, except number of shares) Number Amount
----------------------------------------------------------------------------

Balance, December 31, 2006 15,539,979 $ 33,314
Future income taxes on flow-through share issue - (1,791)
Shares repurchased and cancelled (116,000) (260)
------------ -----------
Balance, September 30, 2007 15,423,979 $ 31,263
------------ -----------
------------ -----------


(c) Flow-through share issue

On April 18, 2006 the Company issued, through a private placement, 1,000,000 common shares on a "flow-through" basis at a price of $6.10 per share for net proceeds (after share issue costs of $446,000) of $5,654,000. The Company is obligated to incur $6.1 million of qualifying expenditures prior to December 31, 2007. At September 30, 2007, there was no remaining obligation. The Company filed the renouncement documents with the tax authorities in 2007 resulting in the $1.8 million reduction of share capital for the future income tax effect.

(d) Shares repurchased and cancelled

In November 2006, the Company received regulatory approval under the Canadian securities laws to purchase and cancel up to 1,300,000 common shares under a normal course issuer bid. The issuer bid will terminate on November 6, 2007. During the nine month interim period ended September 30, 2007, the Company purchased 116,000 common shares for total consideration of $316,000. Of the amount paid, $260,000 was charged to share capital and $56,000 was charged to contributed surplus. Since the commencement of the normal course issuer bid the Company has purchased 146,000 common shares for total consideration of $418,000.



6. Stock-based Compensation

(a) Stock options

The following table sets forth a reconciliation of the stock option plan
activity for the nine months ended September 30, 2007:

Weighted
average
Number of exercise
options price
----------------------------------------------------------------------------

Balance, December 31, 2006 1,451,000 $ 2.94
Granted 65,000 2.80
Cancelled (6,000) -
-----------
Balance, September 30, 2007 1,510,000 $ 2.93
-----------
-----------

The fair value of the options granted during the period was estimated on
the date of the grant using the Black-Scholes option pricing model with
weighted average assumptions and resulting value for the grant as follows:

Options and
warrants Expected Risk-free Total fair
Grant date granted volatility interest rate value
----------------------------------------------------------------------------
(%) (%) ($ thousands)
April 10, 2007 65,000 48 4.1 77


(b) Contributed surplus

The following table reconciles the Company's contributed surplus for the
periods ended as indicated.

Nine Months
Ended Year Ended
September 30, December 31,
($ thousands) 2007 2006
----------------------------------------------------------------------------
Balance, beginning of period $ 820 $ 393
Stock-based compensation expense 121 322
Capitalized stock-based compensation 144 211
Exercise of options and performance warrants - (19)
Settlement of performance warrants - (52)
Reacquisition and cancellation of common
shares (note 5 (d)) (56) (35)
------------ ------------
Balance, end of period $ 1,029 $ 820
------------ ------------
------------ ------------


7. Per Share Amounts

Per share amounts have been calculated using the basic weighted average number of common shares outstanding of 15,449,341 and 15,468,232 during the three and nine month periods ended September 30, 2007 (15,569,979 - three months ended September 30, 2006 and 15,153,520 - nine months ended September 30, 2006). For the three month period ended September 30, 2007, a total of 137,087 (523,076 - 2006) common shares were added to the total to take into account the dilutive effect of the options and performance warrants for the period. A total of 214,651 common shares were added to take into account the dilutive effect during the nine month period ended September 30, 2007 (705,594 - 2006).



8. Future Income Taxes

(a) The provision for income tax expense differs from that which would be
expected from applying the combined effective Canadian federal and
provincial income tax rate of 32.12% (34.5% - 2006) to income before income
taxes. The difference results from the following:

Three Months Ended Nine Months Ended
September 30, September 30,
($ thousands) 2007 2006 2007 2006
----------------------------------------------------------------------------
Expected income tax expense $ 124 $ 413 $ 305 $ 766

Increase (decrease) resulting from:
Non-deductible crown payments - 88 - 350
Resource allowance - (104) - (321)
Impact in effective tax rate
applied (17) (138) (82) (439)
Stock based compensation expense 11 40 39 133
Other 1 85 (38) (102)
-------- ------- -------- --------
Total future income taxes $ 119 $ 382 $ 224 $ 387
-------- ------- -------- --------
-------- ------- -------- --------


(b) The components of the future income tax liability are as follows:

September December 31,
($ thousands) 30, 2007 2006
----------------------------------------------------------------------------
Carrying value of property and equipment
in excess of available tax deductions $ 5,741 $ 3,718
Asset retirement obligation (1,066) (1,036)
Share issuance costs (147) (227)
Attributed Canadian Royalty Income (172) (172)
----------- -----------
$ 4,356 $ 2,283
----------- -----------
----------- -----------


9. Derivative Instruments

The Company has a price risk management program whereby the commodity price associated with a portion of its future production can be fixed. The Company is able to sell forward a portion of its future production through a combination of fixed price sale contracts with customers and commodity swap agreements with financial counterparties. The forward contracts are subject to market risk from fluctuating commodity prices.

The Company uses derivative instruments to reduce its exposure to fluctuations in commodity prices. The following table summarizes the derivative contract in place at September 30, 2007:



Daily Notional
Product Index Term Volume Price Received
----------------------------------------------------------------------------
Gas Fixed AECO-C Apr.1/07 - Oct.31/07 1,500 GJ $7.54 per GJ


Masters Energy Inc. is an Alberta based corporation engaged in the business of acquiring or exploring for and developing oil and natural gas reserves in western Canada. Masters' common shares are listed on the Toronto Stock Exchange under the trading symbol "MSY".

ADVISORY

The Toronto Stock Exchange has neither approved nor disapproved of the information contained herein. Certain information regarding the Company, including management's assessment of future plans and operations, may constitute forward-looking statements under applicable securities law and necessarily involve risks associated with oil and gas exploration, production, marketing and transportation such as loss of market, volatility of prices, currency fluctuations, impression of reserve estimates, environmental risks, competition from other producers and ability to access sufficient capital from internal and external sources: as a consequence, actual results may differ materially from those anticipated. The Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results could differ from those contemplated by the forward-looking statements.

Contact Information

  • Masters Energy Inc.
    Geoff Merritt
    President and CEO
    (403) 290-1785
    or
    Masters Energy Inc.
    Randall Boyd
    Chief Financial Officer
    (403) 290-1785
    Website: www.mastersenergy.com