Vaquero Energy Ltd.
TSX : VAQ

Vaquero Energy Ltd.

May 12, 2005 20:04 ET

Vaquero Energy Ltd. Announces First Quarter 2005 Results

CALGARY, ALBERTA--(CCNMatthews - May 12, 2005) - Vaquero Energy Ltd. (TSX:VAQ) is pleased to announce that its production increased by 21% in the first quarter 2005 to 3,217 boe/d from 2,657 boe/d produced in the same period in 2004. Cash flow from operations during the period increased by 41% to $8,049,790 from $5,721,360 in the first quarter 2004. Net earnings during the quarter increased by 9% to $2,543,978 from $2,332,195 during the same period in 2004.

Highlights

- Vaquero entered into a merger agreement with Highpine Oil & Gas Limited on April 6, 2005.

- Drilled a Pembina Nisku oil pool discovery at 9-35, Vaquero's 10th Nisku discovery.

- Production averaged 3,217 boe/d, up 21% from first quarter 2004.

- Cash flow up 41% from the same quarter in 2004 to $8.0 million.

- Net earnings increased by 9% to $2.5 million from the first quarter 2004.

- Drilled 12 (7.2 net) wells resulting in 2 (0.55 net) successful Nisku oil wells and 5 (3.5 net) successful natural gas wells.

- Continued construction on the 15,000 bbl/d oil battery in Pembina at 16-29-48-9 W5M.

Production

A successful natural gas drilling program in the Windfall and McLeod/Goodwin areas during the first quarter enabled Vaquero to increase natural gas production to over 10 mmcf/d early in the second quarter. By mid-April the Company's production averaged approximately 3,900 boe/d with crude oil and natural gas liquids averaging approximately 2,200 bbls/d and natural gas over 10 mmcf/d.

Vaquero expects further crude oil and associated solution gas production additions in the Pembina area late in the second quarter when the Highpine operated oil battery at 16-29 is completed. Initially, Vaquero will have two (0.65 net) wells producing into the battery with a third well (0.4 net) expected to be brought on-stream later in the year.

Vaquero's production for the first quarter averaged 3,217 boe/d, up 21% from the first quarter 2004. Crude oil and natural gas liquids production in the quarter averaged 1,822 bbls/d, up 32% from the same period in 2004. The Company's operated production in Pembina was curtailed for the first week of January and then shut-in for three days due to operational problems with a sour gas compressor, which was replaced. Production from the Nisku II pool increased in March when Good Production Practice approval was granted. Natural gas production in the quarter averaged 8.4 mmcf/d, up 9% from the first quarter 2004.

Activity

During the first quarter, the Company drilled 12 (7.2 net) wells resulting in 2 (0.55 net) successful Nisku oil wells, 5 (3.5 net) successful natural gas wells and 5 (3.2 net) dry and abandoned wells. Of the five successful natural gas wells, three were in Windfall and two were in McLeod/Goodwin.

During the first quarter, Vaquero completed seismic programs on existing Company lands in the Pembina, McLeod and Goodwin areas. Also during the quarter, the Company increased its net undeveloped land holdings in Pembina area by 5,100 acres, bringing its total net undeveloped land holdings to 19,450 acres in the area.

Highpine Transaction

On April 6, 2005 the Corporation entered into a merger agreement with Highpine Oil and Gas Limited ("Highpine"), whereby Highpine will acquire all of the issued and outstanding shares of the Corporation pursuant to a Plan of Arrangement (the "Arrangement") subject to both approval by the Corporation's shareholders at an Annual and Special Meeting scheduled for May 31, 2005, and regulatory approval. Under the Arrangement, shareholders of the Corporation will receive for each common share of the Corporation held 0.391 of a class "A" common share of Highpine.

Vaquero Energy Ltd. is a Canadian company adding value through exploration, development and production of oil and natural gas primarily in west central Alberta. Vaquero's common shares are listed on the Toronto Stock Exchange under the trading symbol "VAQ".

Vaquero's news releases can be accessed electronically through its website at http://www.vaquero.ca and the website of CCNMatthews at http://www.ccnmatthews.com.

Forward Looking Statements

This press release may contain forward-looking statements including expectations of future operational results, production, cash flow and earnings. These statements are based on current expectations that involve a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. These risks include, but are not limited to: the risks associated with the oil and gas industry (e.g. operational risks in development, exploration and production; delays or changes in plans with respect to exploration or development projects or capital expenditures; the uncertainty of reserve estimates; the uncertainty of estimates and projections relating to production, costs and expenses; and health, safety and environmental risks), commodity price, price and exchange rate fluctuation and uncertainties resulting from the potential delays or changes in plans with respect to exploration or development projects or capital expenditures. Additional information on these and other factors that could affect Vaquero's operations or financial results are included in Vaquero's reports on file with Canadian securities regulatory authorities and may be accessed through the SEDAR website (www.sedar.com), at Vaquero's website (www.vaquero.ca) or by contacting Vaquero.



VAQUERO ENERGY LTD.
FIRST QUARTER 2005 HIGHLIGHTS


Three Months Ended
March 31
2005 2004 % change
------------------------------------------------------------------------
FINANCIAL ($)
------------------------------------------------------------------------

Petroleum and natural gas sales 14,855,896 10,016,798 48

Cash flow from operations 8,049,790 5,721,360 41
Per share (basic) 0.17 0.13 31
Per share (diluted) 0.16 0.13 23

Net earnings 2,543,978 2,332,195 9
Per share (basic) 0.05 0.05 -
Per share (diluted) 0.05 0.05 -

Capital expenditures, net 22,444,926 13,486,036 66

Debt, including working
capital deficit 37,751,671 12,694,507 197

Total assets 126,751,919 61,174,820 107

Shareholders' equity 60,028,035 34,964,012 72

Weighted average common shares
outstanding 47,335,358 43,334,219 9

OPERATING
------------------------------------------------------------------------
AVERAGE DAILY PRODUCTION
------------------------------------------------------------------------
Crude oil & NGLs (bbls/d) 1,822 1,381 32
Natural gas (mmcf/d) 8.4 7.7 9
Barrels of oil equivalent
(boe/d) (6:1) 3,217 2,657 21

AVERAGE PRODUCT PRICES
------------------------------------------------------------------------
Crude oil & NGLs ($/bbl) 55.75 42.87 30
Natural gas ($/mcf) 7.53 6.70 12
------------------------------------------------------------------------
------------------------------------------------------------------------


Message to Shareholders

Management's Discussion and Analysis of Financial Results

Management's discussion and analysis (MD&A) of financial results should be read in conjunction with the unaudited financial statements and notes for the three months ended March 31, 2005 and with the audited financial statements and notes for the years ended December 31, 2004 and 2003. This discussion offers management's opinion of Vaquero's historical financial and operating results and is dated and based on information available at May 12, 2005. All comparisons refer to the three month period ended March 31, 2005 with the same period ended 2004, unless otherwise indicated.

The MD&A uses the terms "cash flow from operations" and "cash flow per share" which are not recognized measures under Canadian generally accepted accounting principles (GAAP). Management believes that in addition to net earnings, cash flow is a useful supplemental measure as it provides an indication of the results generated by the Company's principal business activities prior to the consideration of how those activities are financed or how the results are taxed. Investors are cautioned, however, that this measure should not be construed as an alternative to net earnings determined in accordance with GAAP as an indication of Vaquero's performance. Vaquero's method of calculating cash flow may differ from other companies, and accordingly, it may not be comparable to measures used by other companies. Vaquero calculates cash flow from operations as "funds from operations" prior to the change in non-cash working capital related to operating activities. In addition, the terminology "cash flow" and "funds from" are used interchangeably.

Where amounts are expressed on a barrel of oil equivalent (boe) basis, natural gas volumes have been converted to barrel of oil equivalent (boe) at a ratio of 6,000 cubic feet of natural gas to one barrel of oil equivalent. This conversion ratio is based upon an energy equivalent conversion method primarily applicable at the burner tip and does not represent value equivalence at the wellhead. Boe figures may be misleading, particularly if used in isolation.

All references to dollar values refer to Canadian dollars unless otherwise stated.

Subsequent event

On April 6, 2005 the Corporation entered into a merger agreement with Highpine Oil and Gas Limited ("Highpine"), whereby Highpine will acquire all of the issued and outstanding shares of the Corporation pursuant to a Plan of Arrangement (the "Arrangement") subject to both approval by the Corporation's shareholders at an Annual and Special Meeting dated May 31, 2005, and regulatory approval. Under the Arrangement, shareholders of the Corporation will receive for each common share of the Corporation held 0.391 of a class "A" common share of Highpine.

The Corporation has agreed to pay Highpine a non-completion fee in the amount of $10.9 million in certain circumstances if the Arrangement is not completed.

Production

Production for the three months ended March 31, 2005 increased by 3%, to 3,217 boe/d from 3,119 boe/d in the fourth quarter of 2004, and by 21% compared to 2,657 boe/d for the first quarter of 2004. Vaquero operated production in Pembina was curtailed for the first week of January and then shut-in for three days due to operational issues with a sour gas compressor which was replaced (as previously released).

Crude oil and natural gas liquids production in the first quarter of 2005 increased 32% to 1,822 bbls/d from 1,381 bbls/d in the same period in 2004, primarily due to production increases in the Pembina area. Vaquero expects production additions in the Pembina area late in the second quarter of 2005, when the Highpine operated oil battery at 16-29 becomes operational. Initially, Vaquero will have two (0.65 net) wells producing into the battery with a third well (0.4 net) expected to be brought on-stream later in the year.

During the first quarter of 2005 natural gas production increased 9% to 8.4 mmcf/d from 7.7 mmcf/d during the same period in 2004, primarily due to production additions at Windfall. With a successful first quarter drilling program, by mid-April Vaquero increased natural gas production to over 10 mmcf/d.



------------------------------------------------------------------------
Three months ended March 31
2005 2004 % change
---------------------------------------
Crude oil & NGLs (bbls/d) 1,822 1,381 32
Natural gas (mmcf/d) 8.4 7.7 9
Total boe/d (6:1) 3,217 2,657 21
------------------------------------------------------------------------


Revenue

Revenue from petroleum and natural gas sales was $14,855,896 in the first quarter of 2005, an increase of 9% from $13,580,427 in the fourth quarter 2004. This increase was primarily due to the 3% increase in production and the 17% increase in crude oil and natural gas liquids prices, partially offset by 4% lower natural gas prices.

When compared to the three month period ended March 31, 2004, revenue shows an increase of 48% from $10,016,798. This increase was due to the 21% increase in production, a 30% increase in crude oil and natural gas liquids prices, and a 12% increase in natural gas prices. Natural gas averaged $7.53/mcf and crude oil and natural gas liquids averaged $55.75/bbl, compared with $7.85/mcf and $47.51/bbl, respectively, in the fourth quarter of 2004 and $6.70/mcf and $42.87/bbl, respectively, in the first quarter of 2004.

Financial Instruments

Vaquero makes use of commodity hedging instruments to reduce the variability of cash flows due to fluctuations in crude oil and natural gas prices and to ensure a source of funding for its capital expenditure program. The Company will usually use collars as a form of commodity price protection while maintaining some price upside. The Board of Directors approves all hedges.

The Company had a costless West Texas Intermediate crude oil hedge for the period January 1 to March 31, 2005. The hedge was for 500 barrels of oil per day with a price range of $37.00 US/bbl - $51.30 US/bbl. Net settlement payments of $580,479 were made for this hedge during the three months ended March 31, 2005 and were included in petroleum and natural gas sales. These payments reduced the Company's crude oil and natural liquids average price by $3.54/bbl as a result of the settlement of this hedge.

The Corporation has the following contracts outstanding at March 31, 2005:



------------------------------------------------------------------------
Pricing Cost/
Contract Volume Point Strike Price Premium Term
------------------------------------------------------------------------
Crude Oil
Costless
Collar 500 bbls/d WTI US$42.00 -- Apr 1/05 -
$53.50 n/a Jun 30/05
------------------------------------------------------------------------
Costless
Collar 200 bbls/d WTI US$47.00 -- Apr 1/05 -
$55.84 n/a Jun 30/05
------------------------------------------------------------------------
Costless
Collar 700 bbls/d WTI US$45.00 -- n/a Jul 1/05 -
$54.50 Sep 30/05
------------------------------------------------------------------------
Natural Gas
Costless
Collar 3,000 GJ/d AECO Cdn$5.75 -- n/a Apr 1/05 -
$7.45 Oct 31/05
------------------------------------------------------------------------
------------------------------------------------------------------------


Had these hedges settled on March 31, 2005, the Company would have made settlement payments of $1,140,000. Due to the subsequent reduction of both WTI and natural gas prices at AECO, the Company would have made settlement payments of approximately $386,000 had these hedges settled on May 10, 2005.

Vaquero has applied the guidance under AcG-13, documenting all of these collars as hedges and testing them for effectiveness at the hedges inception and on an on-going basis. The Company does not have any outstanding off-balance sheet arrangements.

Royalties

Royalties were 84% higher in the first quarter of 2005 compared to the same period in 2004, $4,568,205 from $2,487,139. As a percentage of revenue, royalty rates increased slightly to 31% in the first quarter of 2005, compared to 30% during the fourth quarter of 2004. However, royalty rates as a percentage of revenue increased by 24% to 31% in the first quarter of 2005 from 25% in the same period in 2004.

Royalty amounts increased due to both the 48% increase in total revenue and the 24% increase in royalty rates. The royalty rate as a percentage of revenue increased in the first quarter of 2005 from 2004 due to the increase in production rates in Pembina as a result of Good Production Practice (GPP) being approved on various pools during the second half of 2004 and early 2005.

Production Expenses

Production expenses for the first quarter of 2005 were $1,073,922 or an 8% decrease from the $1,172,514 recorded in the first quarter of 2004. This was attributable to the 24% decrease in production costs on a barrel of oil equivalent basis to $3.71/boe in the first quarter of 2005 from $4.85/boe in the same period in 2004. The decrease to the first quarter 2005 operating cost rate is due to production increases in Pembina as a result of GPP being approved on various pools during the second half of 2004 and early 2005.

The first quarter rate of $3.71/boe was very similar to the fourth quarter 2004 rate of $3.72/boe.

Transportation Expenses

Transportation expenses for the three month period ended March 31, 2005 were $43,980 compared to $111,748 in 2004 and on a per unit basis were $0.06/mcf and $0.16/mcf, respectively. Vaquero had lower transportation costs in 2005 on a per unit basis, due to assigning some of its transportation obligations to one of the Company's natural gas purchasers. The Company expects its transportation expense to increase during the year as new natural gas production is brought on-stream.

"Transportation expenses" are defined as expenses incurred by the Company to transport production volumes to market, where the Company reserves the transportation in its name and, in most cases, is obligated to pay for the transportation whether or not it is utilized. Where third parties carry the future transportation obligation, those costs will not be included as a transportation expense. Therefore all of Vaquero's "transportation expenses" are related to natural gas deliveries to market.

General and Administrative Expenses

General and administrative expenses for the first quarter 2005 were $887,550, up 73% from $514,258 for the same three-month period in 2004. General and administrative expenses in the first quarter of 2005 were up 17% from $756,040 for the fourth quarter of 2004.

On a unit-of-production basis, general and administrative expenses increased by 36% to $2.89/boe during the period ended March 31, 2005 from $2.13/boe during the same period in 2004. Expenses on a unit-of-production basis increased due to the effect of additional salary, benefit and office space requirements involved in having fifteen employees for the entire first quarter of 2005 compared to having twelve employees for most of the first quarter of 2004. Other reasons for this increase were an engineering evaluation completed at March 31, 2005 and the increases to salaries of some employees during 2005.

During the three month period ended March 31, 2005, $349,630 of general and administrative costs relating to exploration and development activities was capitalized, compared to $211,960 in 2004. As a percentage of total general and administrative expenses incurred, 28% was capitalized in 2005 compared to 29% in 2004.

Interest Expense

Interest expense for the three month period ended March 31, 2005 was $259,804 compared to $32,630 in 2004. Interest expense rose due to the increase in the average debt level carried by the Company resulting from the increase in capital expenditures net of the increase to cash flow during the year. On a unit-of-production basis, interest expense increased to $0.90/boe in 2005 from $0.13/boe in 2004.

Depletion, Depreciation and Accretion

Depletion, depreciation and accretion expenses for the three-month period ended March 31, 2005 were $3,698,455 compared to $2,135,596 for the same period in 2004. The 73% increase for the three-month period was the result of the 21% increase in production during the same period and a 45% increase on the depletion, depreciation and accretion rate. On a unit-of-production basis, the depletion, depreciation and accretion rate increased by 45% to $12.77/boe from $8.83/boe during 2005 compared to 2004. The depletion and depreciation rate increased due to generally higher finding and on-stream costs and increasing costs associated with the highly competitive Pembina area.

Income and Capital Taxes

Current capital tax expense for the period ended March 31, 2004 was $25,000 consisting entirely of Large Corporation Tax compared with an expense of $22,000 for the same period in 2004. Future income taxes were $1,756,744 in 2005 compared to $1,219,802 in 2004. The increase to future income taxes is a direct result of the increase in petroleum and natural gas sales, which resulted in higher earnings in 2005.

As at March 31, 2005, the Company has satisfied its obligations, pursuant to the $3,002,550 flow-through share offering in December 2004.

Net Earnings and Cash Flow from Operations

Net earnings increased by 9% in the first quarter of 2005 to $2,543,978 from $2,332,195 in 2004. Earnings per share remained at $0.05 basic and diluted in 2005 compared to the same period in 2004.

Cash flow from operations during the three months ending March 31, 2005 was $8,049,790 an increase of 41% from $5,721,360 for the same period in 2004. Cash flow per share was $0.17 basic and $0.16 diluted, compared with $0.13 basic and diluted in 2004. Cash flow increased in 2005 from 2004, due mainly to the 21% increase in production and increases to commodity pricing. Cash flow from operations increased by 9% in the first quarter of 2005 to $8,049,790 from $7,403,743 in the fourth quarter of 2004, due to the 3% increase in production and higher commodity prices.

Liquidity and Capital Resources

At March 31, 2005, the Company had available a $40.0 million revolving operating demand loan (net of any working capital deficit) and a $5.0 million non-revolving development demand loan with a Canadian chartered bank. Vaquero's net debt, including working capital deficiency, was $37,751,671 at March 31, 2005, which consisted of $33,300,000 drawn on its credit facility and a working capital deficiency of $4,451,671. This compares to net debt, including working capital deficit, of $12,694,507 at March 31, 2004. Vaquero has met all covenants pertaining to its loan agreement.

Vaquero's first quarter capital expenditures were $22,444,926, a 6% increase from the $21,131,929 spent during the fourth quarter of 2004 and a 66% increase from the $13,486,036 spent during the first quarter of 2004. These expenditures are summarized as follows:



Three months ended March 31
-----------------------------
2005 2004
-----------------------------
Land 6,366,914 1,073,438
Geological and geophysical 2,509,122 860,926
Drilling and completions 10,138,839 7,144,619
Equipment and facilities 3,092,969 4,152,489
Capitalized G&A(1) 302,330 184,278
-----------------------------
Total Exploration & Development 22,410,174 13,415,750
Corporate assets 34,752 70,286
-----------------------------
Net Capital Expenditures 22,444,926 13,486,036
-----------------------------
-----------------------------

(1) Capitalized G&A excludes $47,300 and $27,682 for the three month
period ended March 31, 2005 and 2004 (stock-based compensation
expense relating to exploration and development activities).

Funding for the capital expenditures in the first quarter of 2005 was
provided by the following:

$mm
-------
Cash flow from operations 8.0
Proceeds from issuance of shares 1.1
Increase in bank debt 13.9
Decrease in working capital deficit (0.6)
-------
Net capital expenditures 22.4
-------
-------


Contractual Obligations

In the normal course of business Vaquero has obligations which represent contracts and other commitments for the following:



------------------------------------------------------------------------
------------------------------------------------------------------------
Apr - Dec Total
2005 2006-2009 Total
------------------------------------------------------------------------

Operating leases $ 218,549 $ 235,006 $ 453,555
Transportation agreements 240,001 342,219 582,220
------------------------------------------------------------------------
458,550 577,225 1,035,775
Capital expenditure commitments 662,400 2,649,600 3,312,000
Bank Debt 33,300,000 - 33,300,000
------------------------------------------------------------------------
$34,420,950 $ 3,226,825 $ 37,647,775
------------------------------------------------------------------------
------------------------------------------------------------------------


Transaction with related parties

Except for those necessary in the normal course of business, there were no related party transactions during the period ended March 31, 2005.

Selected Summary Financial Information

Vaquero's quarterly growth of revenue net of royalties, net earnings and total assets is attributed to successful drilling operations leading to increases in production and the ability to raise capital in public markets.



(000's)
------------------------------------------------------------------------
Quarterly 2005 2004 2004 2004 2004 2003 2003 2003
Information Q1 Q4 Q3 Q2 Q1 Q4 Q3 Q2
------------------------------------------------------------------------
Revenue, net
of royalties 10,289 9,546 9,179 8,457 7,541 5,191 3,374 3,151
Net earnings 2,544 2,730 2,278 2,463 2,332 1,655 818 723
Earnings per share
- basic 0.05 0.06 0.05 0.06 0.05 0.05 0.02 0.02
- diluted 0.05 0.06 0.05 0.05 0.05 0.04 0.02 0.02
Total assets 126,752 105,096 83,882 70,460 61,175 51,357 42,241 31,466
Total
long-term
liabilities - - - - - - - -


Critical Accounting Estimates and Accounting Policies

The significant accounting policies used by Vaquero are disclosed in the notes to Vaquero's December 31, 2004 audited financial statements and its 2004 annual report. Certain accounting policies require that management make appropriate decisions with respect to the formulation of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Discussion about such accounting policies is included in Management's Discussion and Analysis in the 2004 Annual Report to aid the reader in assessing the critical accounting policies and practices of the Company, and the likelihood of materially different results being reported. Vaquero's management reviews its estimates regularly. The emergence of new information and changed circumstances may result in actual results or changes to estimated amounts that differ materially from current estimates.

Vaquero's assessment of significant accounting policies is not meant to be exhaustive. The Company might realize different results from the application of new accounting standards promulgated, from time to time, by various rule-making bodies.

Special Note Regarding Forward-Looking Statements

Certain statements in this interim report including those appearing in the Management's Discussion and Analysis are forward-looking statements subject to substantial known and unknown risks and uncertainties, most of which are beyond Vaquero's control. These risks may cause actual financial and operating results, performance, levels of activity and achievements to differ materially from those expressed in, or implied by, such forward-looking statements.

Such factors include, but are not limited to: the impact of general economic conditions in Canada and the United States; industry conditions including changes in laws and regulations including adoption of new environmental laws and regulations, and changes in how they are interpreted and enforced; competition; the lack of availability of qualified personnel or management; fluctuations in commodity prices; the results of exploration and development drilling and related activities; imprecision in reserve estimates; the production and growth potential of the Company's various assets; fluctuations in foreign exchange or interest rates; stock market volatility; risks associated with hedging activities; and obtaining required approvals of regulatory authorities.

Accordingly, there is no assurance that the expectations conveyed by the forward-looking statements will prove to be correct. All subsequent forward-looking statements, whether written or orally attributable to the Company or persons acting on its behalf, are expressly qualified in their entirely by these cautionary statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements.



VAQUERO ENERGY LTD.
Balance Sheets

------------------------------------------------------------------------
March 31, December 31,
2005 2004
------------------------------------------------------------------------
(unaudited) (audited)
Assets

Current assets:
Cash $ 39,184 $ 48,690
Accounts receivable 14,589,073 11,888,924
Prepaid expenses and deposits 258,836 207,354
------------------------------------------------------------------------
14,887,093 12,144,968

Property, plant and equipment (note 2) 111,864,826 92,951,236

$ 126,751,919 $ 105,096,204

Liabilities and Shareholders' Equity

Current liabilities:
Accounts payable and accrued
liabilities $ 19,338,764 $ 17,170,788
Bank debt (note 4) 33,300,000 19,400,000
-----------------------------------------------------------------------
52,638,764 36,570,788

Asset retirement obligations (note 3) 1,191,705 1,071,886

Future income taxes 12,893,415 10,108,898

Shareholders' equity:
Share capital (note 5) 42,637,455 42,532,931
Contributed surplus (note 5(e)) 480,946 446,045
Retained earnings 16,909,634 14,365,656
-----------------------------------------------------------------------
60,028,035 57,344,632
Commitments (note 7)
Subsequent event (note 8)
------------------------------------------------------------------------
$ 126,751,919 $ 105,096,204
------------------------------------------------------------------------
------------------------------------------------------------------------
See accompanying notes to interim financial statements.

Approved by the Board:



Bill Maslechko Robert N. Waldner
Director Director


VAQUERO ENERGY LTD.
Statements of Operations and Retained Earnings

(Unaudited)

------------------------------------------------------------------------
Three months ended March 31,
2005 2004
------------------------------------------------------------------------


Revenue:
Petroleum and natural gas sales $ 14,855,896 $ 10,016,798
Royalties (net of ARTC) (4,568,205) (2,487,139)
Interest income 1,742 11,084
-----------------------------------------------------------------------
10,289,433 7,540,743

Expenses:
Production 1,073,922 1,172,514
Transportation 43,980 111,748
General and administration 887,550 514,258
Depletion, depreciation and accretion 3,698,455 2,135,596
Interest 259,804 32,630
-----------------------------------------------------------------------
5,963,711 3,966,746

------------------------------------------------------------------------
Earnings before taxes 4,325,722 3,573,997

Taxes:
Capital taxes 25,000 22,000
Future income taxes 1,756,744 1,219,802
-----------------------------------------------------------------------
1,781,744 1,241,802

------------------------------------------------------------------------
Net earnings for the period 2,543,978 2,332,195

Retained earnings, beginning of period 14,365,656 4,561,615

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

Retained earnings, end of period $ 16,909,634 $ 6,893,810
------------------------------------------------------------------------
------------------------------------------------------------------------

Earnings per share (note 6):
Basic and diluted $ 0.05 $ 0.05
------------------------------------------------------------------------
------------------------------------------------------------------------

Weighted average common shares outstanding
during the period 47,335,358 43,334,219
------------------------------------------------------------------------
------------------------------------------------------------------------

See accompanying notes to interim financial statements.



VAQUERO ENERGY LTD.
Statements of Cash Flows

(Unaudited)

------------------------------------------------------------------------
Three months ended March 31,
2005 2004
------------------------------------------------------------------------

Cash provided by (used in):

Operations:
Net earnings for the period $ 2,543,978 $ 2,332,195
Items not involving cash:
Stock-based compensation 50,613 33,767
Depletion, depreciation and accretion 3,698,455 2,135,596
Future income taxes 1,756,744 1,219,802
----------------------------------------------------------------------
Funds from operations 8,049,790 5,721,360
Change in non-cash working capital (2,467,479) (137,975)
----------------------------------------------------------------------
5,582,311 5,583,385

Financing:
Increase in bank debt 13,900,000 1,800,000
Issue of common shares 1,069,285 33,250
Share issue costs - (7,441)
-----------------------------------------------------------------------
14,969,285 1,825,809

Investing:
Property, plant and equipment additions (22,444,926) (13,486,036)
Change in non-cash working capital 1,883,824 4,041,366
-----------------------------------------------------------------------
(20,561,102) (9,444,670)

------------------------------------------------------------------------
Change in cash (9,506) (2,035,476)

Cash, beginning of period 48,690 2,056,342

------------------------------------------------------------------------
Cash, end of period $ 39,184 $ 20,866
------------------------------------------------------------------------
------------------------------------------------------------------------

Payments:
Interest $ 259,804 $ 32,630
------------------------------------------------------------------------
------------------------------------------------------------------------


VAQUERO ENERGY LTD.
Notes to the Financial Statements

Three months ended March 31, 2005 and 2004
(Unaudited)


1. Significant accounting policies:

The interim financial statements of Vaquero Energy Ltd. (the "Corporation") have been prepared by Management in accordance with Canadian generally accepted accounting principles. The interim financial statements have been prepared following the same accounting principles and methods of computation as the financial statements for the fiscal year ended December 31, 2004. The disclosures provided below are incremental to those included with the annual financial statements. The interim financial statements should be read in conjunction with the financial statements and the notes thereto in Vaquero Energy Ltd.'s annual report for the year ended December 31, 2004.



2. Property, plant and equipment:

------------------------------------------------------------------------
Accumulated
depletion
and Net book
March 31, 2005 Cost depreciation value
------------------------------------------------------------------------

Oil and gas properties $ 116,941,216 $ 26,505,962 $ 90,435,254
Equipment and facilities 24,585,972 4,158,909 20,427,063
Asset retirement cost 1,004,793 236,167 768,626
Other 924,833 690,950 233,883

------------------------------------------------------------------------
$ 143,456,814 $ 31,591,988 $111,864,826
------------------------------------------------------------------------
------------------------------------------------------------------------

December 31, 2004
------------------------------------------------------------------------

Oil and gas properties $ 97,576,711 $ 23,555,113 $ 74,021,598
Equipment and facilities 21,493,003 3,493,167 17,999,836
Asset retirement cost 904,793 208,512 696,281
Other 890,081 656,560 233,521

------------------------------------------------------------------------
$ 120,864,588 $ 27,913,352 $ 92,951,236
------------------------------------------------------------------------
------------------------------------------------------------------------


As at March 31, 2005, undeveloped costs of $32,703,000 (March 31, 2004 - $9,660,000) were excluded from the depletion calculation, and future development costs of $3,316,000 (March 31, 2004 - $2,183,000) were included in the depletion calculation.

During the three months ended March 31, 2005, the Corporation capitalized $349,630 (March 31, 2004 - $211,960) of general and administrative costs relating to exploration and development activities. Stock-based compensation of $47,300 (March 31, 2004 - $27,682) was included in these capitalized costs.

3. Asset retirement obligations:

The Corporation's asset retirement obligations result from net ownership interests in petroleum and natural gas assets including well sites, gathering systems and processing facilities. The Corporation estimates the total undiscounted amount of cash flows required to settle its asset retirement obligations is approximately $2,034,802 as at December 31, 2004. The majority of the costs will be incurred between 2007 and 2028. A credit-adjusted risk free rate of 8% was used to calculate the fair value of the asset retirement obligations.



A reconciliation of the asset retirement obligations is provided below:

------------------------------------------------------------------------
------------------------------------------------------------------------
March 31, December 31,
2005 2004
------------------------------------------------------------------------

Balance, beginning of year $ 1,071,886 $ 813,230

Accretion expense 19,819 67,628
Liabilities incurred 100,000 191,028

------------------------------------------------------------------------
Balance, end of year $ 1,191,705 $ 1,071,886
------------------------------------------------------------------------
------------------------------------------------------------------------


4. Bank debt:

At March 31, 2005, the Corporation had available a $40.0 million revolving operating demand loan facility and a $5.0 million non-revolving development demand loan facility from a Canadian chartered bank. The revolving operating demand loan facility bears interest at the lender's prime rate, adjusted quarterly based on the Corporations' debt to cash flow ratio. The loans are secured by a $75.0 million first floating demand debenture covering all of the Corporation's assets. No amounts were drawn under the non-revolving development demand loan at March 31, 2005.

During the three months ended March 31, 2005, advances under the Corporation's revolving operating demand facility bore interest at a weighted average rate of 4.25% (March 31, 2004 - 4.48%).



5. Share capital:

a) Authorized:

Unlimited number of common shares without nominal or par value.

Unlimited number of first and second preferred shares, of which none
have been issued.

------------------------------------------------------------------------
------------------------------------------------------------------------
Number
of Shares Amount
------------------------------------------------------------------------

Balance, December 31, 2003 43,329,439 $ 27,843,249
Issued on exercise of stock options 378,250 373,975
Issued common shares 3,299,700 15,002,895
Transfer from contributed surplus on
exercise of stock options - 18,400
Share issuance costs (net of future
taxes of $386,385) - (705,588)
------------------------------------------------------------------------
Balance, December 31, 2004 47,007,389 42,532,931

Issued on exercise of stock options 893,250 1,069,285
Transfer from contributed surplus on
exercise of stock options - 63,012
Future income tax effect of 2004
renouncements - (1,027,773)
------------------------------------------------------------------------
Balance, March 31, 2005 47,900,639 $ 42,637,455
------------------------------------------------------------------------
------------------------------------------------------------------------

(c) Stock options:

Stock options issued and outstanding are as follows:

------------------------------------------------------------------------
------------------------------------------------------------------------
Three months ended Year ended
March 31, 2005 December 31, 2004
------------------------------------------------------------------------
Weighted Weighted
Number average Number average
of exercise of exercise
options price options price
------------------------------------------------------------------------

Outstanding, beginning of period 3,707,200 $ 1.99 3,606,300 $ 1.75
Granted - - 481,900 2.99
Exercised (893,250) 1.20 (378,250) 0.99
Expired or cancelled - - (2,750) 2.28
------------------------------------------------------------------------
Outstanding, end of period 2,813,950 $ 2.24 3,707,200 $ 1.99
------------------------------------------------------------------------
------------------------------------------------------------------------

Exercisable, end of period 1,658,950 $ 2.29 2,492,450 $ 1.92
------------------------------------------------------------------------
------------------------------------------------------------------------


(d) Stock-based compensation:

The weighted average fair value of stock options was $1.21 per option during the three months ended March 31, 2004. The Corporation used the Black-Scholes option pricing model with the following assumptions: risk-free interest rate of 4.0%, expected life of 5 years and expected volatility of 45%.

The Corporation continues to disclose the pro forma impact of stock options granted in 2002. Had compensation expense been determined for options issued during 2002 based upon the fair value at the grant dates for options awarded under the stock option plan, the Corporation's earnings for the three months ended March 31, 2005 would not have been affected. For the three months ended March 31, 2004, the Corporation's earnings per share would have been adjusted to the pro forma amounts indicated below:



------------------------------------------------------------------------
------------------------------------------------------------------------
2004
------------------------------------------------------------------------

Net earnings for the period - as reported $ 2,332,195
Net earnings for the period - pro forma $ 2,273,454
Earnings per share (basic and diluted) - as reported $ 0.05
Earnings per share (basic and diluted) - pro forma $ 0.05
------------------------------------------------------------------------
------------------------------------------------------------------------


(e) Contributed surplus:

------------------------------------------------------------------------
Three Twelve
months ended months ended
March 31, December 31,
2005 2004
------------------------------------------------------------------------

Balance, beginning of period $ 446,045 $ 136,985

Compensation expense 97,913 327,460
Exercise of share options (63,012) (18,400)
------------------------------------------------------------------------
Balance, end of period $ 480,946 $ 446,045
------------------------------------------------------------------------
------------------------------------------------------------------------


(f) Flow through shares:

As at March 31, 2005, the Corporation has satisfied its obligations, pursuant to the $3,002,550 flow-through share offering in December 2004.

6. Per share amounts:

In computing diluted earnings per share, 1,544,176 shares (March 31, 2004 - 1,444,607) were added to the 47,335,358 (March 31, 2004 - 43,334,219) weighted average number of common shares outstanding during the period for the dilutive effect of stock options. During the three months ended March 31, 2005, all options were included in the diluted earnings per share calculation. During the three months ended March 31, 2004, options to purchase 1,112,000 common shares were not included in the computation because they were anti-dilutive. No adjustments were required to reported earnings in computing diluted per share amounts.

7. Financial instruments:

The Corporation had a costless collar West Texas Intermediate crude oil hedge for the period January 1, 2005 to March 31, 2005. The hedge was for 500 barrels of oil per day, with a price range of $37.00 US/bbl - $51.30 US/bbl. Net settlement payments of $580,479 were made for this hedge during the three months ended March 31, 2005 and were included in petroleum and natural gas sales.

The Corporation has the following contracts outstanding at March 31, 2005:



------------------------------------------------------------------------
------------------------------------------------------------------------
Pricing Cost/
Contract Volume Point Strike Price Premium Term
------------------------------------------------------------------------
Crude Oil
------------------------------------------------------------------------
Costless Apr 1/05
Collar 500 bbls/d WTI US$42.00 -- $53.50 n/a - Jun 30/05
------------------------------------------------------------------------
Costless Apr 1/05
Collar 200 bbls/d WTI US$47.00 -- $55.84 n/a - Jun 30/05
------------------------------------------------------------------------
Costless Jul 1/05
Collar 700 bbls/d WTI US$45.00 -- $54.50 n/a - Sep 30/05
------------------------------------------------------------------------
Natural Gas
------------------------------------------------------------------------
Costless Apr 1/05
Collar 3,000 GJ/d AECO Cdn$5.75 -- $7.45 n/a - Oct 31/05
------------------------------------------------------------------------
------------------------------------------------------------------------


Had these hedges settled on March 31, 2005, the Corporation would have made settlement payments of $1,140,000.

8. Subsequent Event:

On April 6, 2005 the Corporation entered into a merger agreement with Highpine Oil and Gas Limited ("Highpine"), whereby Highpine will acquire all of the issued and outstanding shares of the Corporation pursuant to a Plan of Arrangement (the "Arrangement") subject to approval by the Corporation's shareholders at an Annual and Special Meeting dated May 31, 2005, as well as regulatory approval. Under the Arrangement, shareholders of the Corporation will receive for each common share of the Corporation held 0.391 of a class "A" common share of Highpine.

The Corporation has agreed to pay Highpine a non-completion fee in the amount of $10.9 million in certain circumstances if the Arrangement is not completed.

Contact Information

  • Vaquero Energy Ltd.
    Mr. Robb Waldner
    President and Chief Executive Officer
    (403) 537-2031
    Website: http://www.vaquero.ca