Masters Energy Inc.
TSX : MSY

Masters Energy Inc.

March 17, 2008 00:00 ET

Masters Energy Inc. Reports 2007 Results

CALGARY, ALBERTA--(Marketwire - March 17, 2008) - (TSX:MSY) Masters Energy Inc. ("Masters" or the "Company") is pleased to report financial and operating results for the year ended December 31, 2007. Several significant accomplishments to highlight, include the following;

- Increased Net Asset Value to $6.65 per share, based on McDaniel proved and probable reserve evaluation at year-end.

- Production increased nine percent year over year to 1,539 boe per day and exited the 2007 year at 1,690 boe per day.

- Increased proved plus probable reserves 73 percent to 8.3 million boe and increased reserves per share to 53.3 boe (2006 - 30.8) per 100 shares.

- Proved plus probable reserve additions replaced 7.2 times the 2007 production.

- Finding and development and net acquisition, after future capital, averaged $16.76 per boe for the past three years.

- Achieved an average capital investment recycle ratio of 1.7 times for the past three years.




HIGHLIGHTS
Years ended December 31 2007 2006
----------------------------------------------------------------------------
Financial ($ thousands, except per share amounts)
Gross revenue 26,786 24,264

Funds generated by operations (1) 12,527 11,537
Per share - basic 0.81 0.75
- diluted 0.80 0.72

Net earnings 1,500 1,858
Per share - basic 0.10 0.12
- diluted 0.10 0.12

Capital expenditures, net 12,242 18,289

Working capital deficit 2,560 2,156

Long-term debt 18,228 17,824

Operations
Production
------------
Crude oil (bbls/d) 761 784
NGL (bbls/d) 12 10
Natural gas (mcf/d) 4,597 3,685
Total production (boe/d at 6:1) 1,539 1,408

Average sales price
---------------------
Crude oil ($/bbl) 51.76 49.99
NGL ($/bbl) 66.35 63.33
Natural gas ($/mcf) 6.73 6.59

(1) Funds generated by operations is calculated using cash flow from
operating activities as presented in the statement of cash flows before
non-cash working capital and settlement of asset retirement costs.


Presidents Message to the Shareholders

During 2007, Masters Energy made significant progress toward our long term goal of creating value for our shareholders. Work carried out on the enhanced oil recovery project at our Little Bow property has further indicated that significant reserves can be recovered from the existing reservoir. Masters is proceeding toward implementing an alkaline surfactant polymer ("ASP") flood. The oil pool has produced for a total of 33 years and has been under waterflood for 25 of those years. Based on the results of core studies, an incremental 15 to 20 percent of the original oil in place is expected to be recovered by implementing an ASP flood.

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.

Masters' independent reserve evaluator, McDaniel & Associates Consultants Ltd. ("McDaniel"), estimates that the Little Bow pool has 34 million barrels of original oil in place, of which, approximately 33 percent has been recovered to date and approximately 41 percent is estimated to be recovered by the existing waterflood. By implementing the ASP flood, incremental reserves, net to Masters, have been estimated by the independent reserve evaluator to be 3.7 and 4.9 million barrels (13.5 and 18.0 percent incremental recovery factors, respectively) for proved plus probable and proved, probable plus possible, respectively.

The 2007 proved and probable reserves increased 73 percent to 8.3 million boe of which approximately 80 percent of the reserves are crude oil. The estimated proved, probable and possible reserves for 2007 was 9.5 million boe. There were no reserves assigned to the possible category in 2006. Based on McDaniel's forecasted prices and costs the estimated value of proved and probable reserves, discounted at 10 percent before taxes, was $122.8 million and on a proved, probable and possible reserves was $154.1 million. After adding the internally estimated value for undeveloped land and deducting the net debt the estimated net asset value per fully diluted common share is $6.65 on proved and probable reserves and $8.41 on proved, probable and possible reserves. The average Company wellhead price to determine the value of the reserves was $58.50 per barrel of crude and $7.68 per mcf of natural gas. Currently, Masters is receiving in excess of $80.00 per barrel of crude and $8.00 per mcf of natural gas at the wellhead.

The oil and gas industry has experienced some significant challenges recently. The robust activity levels during 2006 created cost pressures on capital spending and operating expenses. Commodity prices fluctuated significantly for medium quality crude oil and natural gas with prices trending lower. In addition, public policy changes such as the Federal government's October 31, 2006 announcement to tax trusts and the Alberta government's October 25, 2007 announcement to increase Crown royalties created a great degree of uncertainty within the capital markets not only for the energy trusts but also for exploration and production companies. As a consequence, the industry as a whole slowed down during 2007 with fewer wells drilled and lower capital spending. Throughout these challenging times Masters has patiently carried out its objectives.

Masters' strategy for 2007 was to continue exploiting our large undeveloped land base and build value within our core areas, while maintaining a strong balance sheet. We made considerable progress on these objectives, as outlined below.

- We exploited our undeveloped land base by drilling or recompleting 19 wells with a 53% success ratio.

- We advanced the Little Bow ASP flood to the point of commercialization and implementation. The pre-tax value, discounted at 10 percent, of our Little Bow property increased 142 percent (total proved plus probable reserves volume increased 147 percent).

- We maintained a strong balance sheet by limiting capital expenditures to $12.2 million on cash flow of $12.5 million.

- Masters asset base grew as we:



- increased annual production by nine percent from 1,408 boe per day to
1,539 boe per day;
- replaced 7.2 times the annual production (on proved plus probable
reserves additions and revisions);
- increased total proved plus probable reserves 73 percent with the
addition of 4.1 million boe of proved plus probable reserves;
- acquired 30,000 acres of undeveloped land.


- We enhanced shareholder value by:



- adding proved plus probable reserves at a finding and development and
net acquisition cost ("FD&A"), inclusive of future capital costs, of
$18.10 per boe for 2007 and a three year average FD&A of $16.76 per
boe;
- investing capital efficiently, achieving a recycle ratio of 1.5 for
2007 and 1.7 for three years;
- controlling our operating costs, $10.39 per boe versus $10.89 per boe
in 2006 and general and administration expenses, $3.42 per boe versus
$3.87 per boe in 2006.
- increasing the reserves per 100 outstanding shares 75 percent to 53.9
boe;
- acquiring and cancelling 184,100 common shares, through normal course
issuer bids, at an average price of $2.55 per share. The estimated net
asset value per fully diluted common share at year end 2007 was $6.65
(2006 - $4.28);
- hedging the price on approximately one third of the natural gas sold
during the summer delivery period resulting in a gain of $0.5 million.


Daily average production for the 2007 year increased nine percent to 1,539 boe per day. The increase was the result of several natural gas tie-ins that were carried out in our core areas. Production for the fourth quarter of 2007 averaged 1,552 boe per day. At year end the exit production was approximately 1,690 boe per day.

For 2008, Masters' strategy is to continue to exploit our Little Bow property with the implementation of a tertiary recovery flood and pursue several high impact exploration plays in areas outside of our core areas. We believe Masters can deliver production averaging 1,600 - 1,800 boe/d in 2008 from internally-generated exploration and development. Plans are to spend $15.5 million on exploration and development activity which will primarily be funded through funds generated by operations. We anticipate this level of capital will allow us to drill 20 - 25 wells.

Our forecasted capital spending for 2008 is based on a Bow River price for medium gravity crude of approximately $53.00 per barrel and an AECO spot price of $6.00 per gigajoule for natural gas. Forward strip prices for Bow River type crude are currently in excess of $80.00 per barrel and $8.00 per gigajoule for natural gas.

Further detailed engineering design and reservoir simulation studies are being carried out before construction of the ASP facility begins at Little Bow. We expect to be able to refine our estimate of the total cost of the project, including the cost of the facilities, field infrastructure and injection chemicals, by the end of the first quarter 2008. An application to implement the enhanced oil recovery project is expected to be submitted to the ERCB subsequent to completing the engineering work currently underway.

The current business environment for the oil and gas sector remains solid. Stronger longer term commodity prices, lower interest rates and higher demand for energy is creating a positive business environment in the oil and gas sector. The demand for oilfield services and supplies are returning to historical levels of activity and timing. During the last quarter of 2007 and the first quarter of 2008, Alberta Crown land auctions for oil and gas rights have seen the lowest prices paid for undeveloped acreage in the past 10 years. This allows us to pursue opportunities in a cost effective manner.

Masters team of experienced, knowledgeable and talented employees, along with the support of the Board of Directors, provide the foundation to continue to of create value for our shareholders. The combination of our team, solid foundation of properties and attractive business fundamentals in the oil and gas sector creates a strong sense of optimism for the future. I am excited by the exploitation opportunities available to us in our core areas and the upside potential which exists in our inventory of exploration prospects.

On behalf of the Board of Directors,

Geoff C. Merritt

President and Chief Executive Officer March 17, 2008



SUMMARY OF RESERVES
-------------------


Masters independent reserve evaluation was prepared by McDaniel in accordance with National Instrument ("NI") 51-101 for the year ended December 31, 2007. The following reserves information has been prepared using McDaniel forecasted prices and costs and Alberta's existing royalty program.



----------------------------------------------------------------------------
Summary of Reserves 2007 2006
----------------------------------------------------------------------------

Proved
Crude Oil (mbbl) 2,107 2,067
Natural Gas Liquids (mbbl) 28 20
Natural Gas (mmcf) 6,447 7,711
BOE (mboe) 3,213 3,373
Proved and Probable ("2P")
Crude Oil (mbbl) 6,532 2,778
Natural Gas Liquids (mbbl) 44 29
Natural Gas (mmcf) 10,225 11,898
BOE (mboe) 8,280 4,790
Proved, Probable and Possible ("3P")
Crude Oil (mbbl) 7,752 2,778
Natural Gas Liquids (mbbl) 44 29
Natural Gas (mmcf) 10,301 11,898
BOE (mboe) 9,514 4,790


Total proved plus probable reserves increased 73% over the previous year from 4,790 mboe to 8,280 mboe as a result of exploration and development activity, property acquisitions and most importantly, the recognition of reserves associated with the proposed enhanced oil recovery project at Little Bow. McDaniel recognized incremental recovery factors of 13.5% and 18% for 2P and 3P reserves, respectively. As of December 31, 2007, the Company proved and probable reserve mix is comprised of 79% crude oil and natural gas liquids and 21% natural gas.

Masters actual reserves and future production will be greater than or less than the estimates provided. The estimated future net revenue from the production of the Company's reserves does not necessarily represent the fair market value of the Company's reserves. In addition, to the reserve information disclosed in this summary, more detailed reserve disclosure in accordance with NI 51-101 is included in the Company's Annual Information Form ("AIF"). A copy of the AIF can be obtained by contacting the Company or visiting its website www.mastersenergy.com or through SEDAR at www.sedar.com.

The following tables summarize Masters working interest reserves and estimated associated values, before income taxes, at December 31, 2007:




Summary of Gross Reserves (1)
----------------------------------------------------------------------------
Natural
Crude Gas Natural Total Total
Reserves Category Oil Liquids Gas 2007 2006
----------------------------------------------------------------------------
(mbbl) (mbbl) (mmcf) (mboe) (mboe)
Proved
Developed producing 1,802 20 5,338 2,712 2,538
Developed non-producing 305 8 1,129 501 835
Undeveloped - - - - -
--------------------------------------------
Total Proved 2,107 28 6,467 3,213 3,373
Probable 4,425 16 3,758 5,067 1,417
--------------------------------------------
Total Proved and Probable 6,532 44 10,225 8,280 4,790
Possible 1,220 1 76 1,234 -
--------------------------------------------
Total Proved, Probable and
Possible(2) 7,752 44 10,301 9,514 4,790
--------------------------------------------
--------------------------------------------
NOTES:
(1) "Gross" reserves means the total working interest (operated and
non-operated) share before deduction of royalties payable to others and
excluding any royalty interests owned (approximately 28 mboe) by
Masters.
(2) May not add due to rounding.


Summary of Oil and Gas Reserve Estimated Net Present Values ("NPV") of
future net revenue (1)

Reserves Category Before Income Taxes Discounted at
----------------------------------------------------------------------------
($ million) 0% 5% 10% 15%
--------------------------------------------
Proved
Developed producing 72.5 61.2 53.2 47.3
Developed non-producing 11.7 9.7 8.3 7.2
Undeveloped - - - -
--------------------------------------------
Total Proved 84.2 70.9 61.4 54.5
Probable 146.0 91.2 61.4 43.0
--------------------------------------------
Total Proved and Probable 230.2 162.0 122.8 97.5
Possible 58.0 40.1 31.3 25.7
--------------------------------------------
Total Proved, Probable and Possible 288.2 202.2 154.1 123.2
--------------------------------------------
--------------------------------------------
NOTE:
(1) May not add due to rounding.


The average wellhead forecasted prices to determine Masters' Net Present Value was $58.50 per barrel of crude oil and $7.68 per mcf of natural gas. Crude oil and natural gas benchmark reference pricing, as at January 1, 2008, inflation and exchange rates utilized by McDaniel were as follows.




Natural
Oil Gas
------------------------------- ---------
Edmonton Bow River
WTI Par Price Medium
Cushing 40 degrees 25 degrees AECO Gas
Year Oklahoma API API Price
----- ---------- ---------- ---------- ----------
($US/bbl) ($Cdn/bbl) ($Cdn/bbl) ($Cdn/GJ)
2008 90.00 89.00 64.70 6.45
2009 86.70 85.70 62.30 7.00
2010 83.20 82.20 59.70 7.00
2011 79.60 78.50 57.00 7.00
2012 78.50 77.40 56.20 7.10
2013 77.30 76.20 55.30 7.30
There after + 2.0%/yr + 2.0%/yr + 2.0%/yr + 2.0%/yr


Natural
Gas
Liquids
----------
Edmonton Inflation Exchange
Year Mix Rates(1) Rate(2)
---- ---------- ---------- ----------
(percent
($Cdn/bbl) per year) ($US/$Cdn)
2008 61.60 2.0 1.00
2009 60.20 2.0 1.00
2010 58.00 2.0 1.00
2011 55.80 2.0 1.00
2012 55.20 2.0 1.00
2013 54.70 2.0 1.00
There after + 2.0%/yr + 2.0%/yr 1.00

Notes:

(1) Inflation rates for forecasting prices and costs.
(2) Exchange rates used to generate the benchmark reference prices in this
table.


Reconciliation of Company Gross Reserves by Principal Product Type
----------------------------------------------------------------------------
Natural
Reserves Gas Natural Total
Category Crude Oil Liquids Gas 2007
----------------------------------------------------------------------------
(mbbl) (mbbl) (mmcf) (mboe)
Total Proved Opening balance 2,067 20 7,711 3,373
Discoveries/extensions 16 - 686 130
Revisions 171 8 (717) 60
Acquisitions 131 4 465 212
Production (278) (4) (1,678) (562)
---------------------------------------------------------------
Closing balance(1) 2,107 28 6,467 3,213
---------------------------------------------------------------
Probable Opening balance 710 9 4,187 1,417
Discoveries/extensions 3,667 1 516 3,754
Revisions (7) 4 (1,131) (193)
Acquisitions 57 1 186 89
Production - - - -
---------------------------------------------------------------
Closing balance(1) 4,425 16 3,758 5,067
---------------------------------------------------------------
Possible Opening balance - - - -
Discoveries/extensions 1,220 1 76 1,234
Revisions - - - -
Acquisitions - - - -
Production - - - -
---------------------------------------------------------------
Closing balance(1) 1,220 1 76 1,234
---------------------------------------------------------------
Total Proved,
Probable and
Possible Opening balance 2,778 29 11,898 4,790
Discoveries/extensions 4,903 2 1,278 4,989
Revisions 164 12 (1,848) (133)
Acquisitions 188 5 651 301
Production (278) (4) (1,678) (562)
---------------------------------------------------------------
Closing balance(1) 7,752 44 10,301 9,514
---------------------------------------------------------------
---------------------------------------------------------------
NOTE:
(1) May not add due to rounding.


Alberta New Royalty Framework

The Government of Alberta has announced changes to the royalties payable, referred to as the New Royalty Framework ("NRF"), on all Crown mineral rights owned by the province. If the NRF is 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, 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. The process to implement these changes is ongoing including industry/government discussions regarding unintended consequences.

The following table summarizes the Net Present Values of the Company, using McDaniel forecasted prices and costs, after taking into account the announced NRF changes.




Reserves Category Before Income Taxes Discounted at
----------------------------------------------------------------------------
($ million) 0% 5% 10% 15%
--------------------------------------------
Proved
Developed producing 66.4 56.3 49.1 43.8
Developed non-producing 10.1 8.4 7.1 6.2
Undeveloped - - - -
--------------------------------------------
Total Proved (1) 76.5 64.7 56.2 50.0
--------------------------------------------
Probable 137.9 86.2 58.0 40.4
Total Proved and Probable (1) 214.3 150.9 114.2 90.4
--------------------------------------------
Possible 48.3 33.3 26.0 21.4
--------------------------------------------
Total Proved, Probable and Possible (1) 262.6 184.2 140.2 111.8
--------------------------------------------
--------------------------------------------
NOTE:
(1) May not add due to rounding.


MANAGEMENT'S DISCUSSION AND ANALYSIS

ADVISORIES

Management's discussion and analysis ("MD&A") of Masters Energy Inc. ("Masters", the "Company", "we" or "our"), provided as of March 14, 2008, should be read in conjunction with the audited financial statements and related notes for the years ended December 31, 2007 and 2006.

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 term '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 or 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 the cash necessary to fund future capital investments and to repay debt. Funds generated by operations is calculated using cash flow from operating activities as presented in the statement of cash flows before non-cash working capital and settlement of asset retirement costs. 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 and net asset value to analyze financial and operating performance. These benchmarks as presented do 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 6 mcf equals 1 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, 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.



RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006

PRODUCTION

2007 2006
--------------------------
Annual Production
Crude oil (bbls) 277,780 286,058
Natural gas liquids ("NGL") (bbls) 4,464 3,773
Natural gas (mcf) 1,677,978 1,345,114
Total (boe) 561,907 514,017
Daily Production
Crude oil (bbls/d) 761 784
NGL (bbls/d) 12 10
Natural gas (mcf/d) 4,597 3,685
Total (boe/d) 1,539 1,408


For the year ended December 31, 2007, total production increased nine percent and averaged 1,539 boe/d (2006 - 1,408 boe/d) with oil production, including NGL, comprising 50 percent (2006 - 56 percent) and natural gas, 50 percent (2006 - 44 percent). Production increased during 2007 as a result of drilling, recompleting and tying-in successful wells.

Based on drilling activity budgeted for 2008 and production expected from existing producing properties, Masters forecasts an average production rate of 1,600 - 1,800 boe/d comprised of 50 percent oil including NGL and 50 percent natural gas.



PRICES
-------

2007 2006
--------------------------
Crude oil ($/bbl) 51.76 49.99
--------------------------
--------------------------
NGL ($/bbl) 66.35 63.33
--------------------------
--------------------------
Natural gas ($/mcf) 6.73 6.59
--------------------------
--------------------------


West Texas Intermediate ("WTI") is the benchmark for North American oil prices and is the crude oil 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 2007, North America experienced historically high price levels for WTI crude oil due to concerns regarding supply. As a result, the average price for a barrel of WTI crude during 2007 increased US$6.14 to US$72.33. During 2007, the Canadian dollar strengthened relative to the US dollar with the average currency exchange rate for $1.00 Canadian increasing to US$0.94 (2006 - US$0.88) . The higher exchange rate reduced the price received for delivery of crude within Canadian markets. The widening quality price differential postings on medium types of crude oil had a negative effect during 2007. The average differential between Edmonton light sweet crude postings and Hardisty Bow River medium crude increased to approximately $23.90 per bbl (2006 - $22.00 per bbl).

In 2007, Masters' average field price for crude oil was $51.76 (2006 - $49.99) per bbl versus $77.00 (2006 - $73.25) per bbl for light sweet postings at Edmonton, Alberta. All crude revenues during 2007 were from sales to spot markets. Masters did not hedge any crude production during 2007. Masters' 2007 crude oil production was 89 percent (2006 - 84 percent) medium and 11 percent (2006 - 16 percent) lighter gravity crude.

The typical reference for US natural gas prices is NYMEX at Henry Hub, Louisiana while the reference for Canadian prices is at Nova Inventory Transfer ("NIT") or the AECO Hub. During the summer delivery period of 2007, Masters entered into a fixed price financial type natural gas sales contract to sell a notational volume of 1,500 GJ per day at $7.54 per GJ. This resulted in a gain of $0.5 million (2006 - nil). The remaining natural gas produced during 2007 and 2006 was 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 levels. However, with record levels of US onshore drilling directed at natural gas prospects and the increase of Liquified Natural Gas ("LNG") imports into North America, natural gas storage levels for 2007 returned to the same levels as 2006. The 2007 -2008 winter within North America has been colder than normal resulting in the storage levels once again returning to within the five-year averages.

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 short to medium term outlook for natural gas prices remains positive.

Masters' average natural gas price in 2007 was $6.73 (2006 - $6.59) per mcf versus $6.32 (2006 - $6.38) per mcf for spot postings of the AECO reference price. During the period April to October 2007 Masters realized a gain of $0.5 million from a fixed price financial contract. The gain increased the average natural gas price contract received by $0.29 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 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.



Subsequent to December 31, 2007, Masters entered into a fixed natural gas
hedge as follows;

Daily Notional
Product Index Term Volume Price Received
----------------------------------------------------------------------------
Apr. 1/08 - Oct.
Gas Fixed AECO-C 31/08 2,500 GJ $7.745 per GJ


The forecasted commodity prices used for Masters' 2008 budget were $76.00 (US$75.00 WTI) per bbl of Edmonton light quality crude oil and Cdn$5.90 per GJ ($6.25 per mcf) for natural gas at the wellhead. Masters' 2008 budget uses a forecasted foreign currency exchange rate estimated to average US$0.97 per Cdn$1.00.



REVENUES
---------

($ thousands, except as indicated) 2007 2006
----------------------------------------------------------------------------
Crude oil revenue 14,379 14,299
NGL revenue 296 239
Natural gas revenue 11,301 8,867
--------------------------
Total petroleum and natural gas revenue 25,976 23,405
Royalty and other revenue 810 859
--------------------------
Total revenue 26,786 24,264
--------------------------
Total petroleum and natural gas revenue per
boe ($) 46.23 45.53
--------------------------
--------------------------
Total revenue per boe ($) 47.67 47.21
--------------------------
--------------------------


Petroleum and natural gas revenue for the 2007 year increased 11 percent to $26.0 million due primarily to a nine percent increase in production and a realized hedging gain of $0.5 million during the year.

Royalty and other revenue decreased by six percent to $0.8 million as a result of certain royalty interests being sold in September 2006.

Based on forecasted production volumes and commodity prices, Masters forecasts an increase in oil and natural gas revenues of approximately 10 - 20 percent during 2008.



ROYALTIES
----------

($ thousands, except as indicated) 2007 2006
----------------------------------------------------------------------------
Crown 4,929 4,296
Alberta Royalty Tax Credit ("ARTC") - (411)
--------------------------
Crown, net of ARTC 4,929 3,885
Freehold and gross overriding 497 509
--------------------------
Total royalties 5,426 4,394
--------------------------
--------------------------
Per boe ($) 9.66 8.55
--------------------------
--------------------------
Average royalty rate (%)(1) 21.3 18.8
--------------------------
--------------------------
(1) A percentage of total petroleum and natural gas revenue


Royalties paid for the year ended December 31, 2007 increased 24 percent as a result of higher Crown rates on oil and natural gas sales and the termination of the ARTC program at the end of the 2006 year. Masters' average royalty rate increased to 21.3 percent during 2007 (2006 - 18.8 percent). The 2007 royalty expense is comprised of 91 percent (2006 - 89 percent) paid to the Crown with the remainder paid to freehold and gross overriding royalty owners. In 2007, Masters' royalties per boe amounted to $9.66 (2006 - $8.55) .

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.

Masters anticipates forecasted royalty rates for 2008 will be moderately higher than our historical rates with increased commodity prices and the expiration of royalty holidays on eligible producing wells.




OPERATING EXPENSES
-------------------

($ thousands except as indicated) 2007 2006
----------------------------------------------------------------------------
Total operating expenses 5,841 5,600
--------------------------
--------------------------
Per boe ($) 10.39 10.89
--------------------------
--------------------------


In 2007, operating expenses per boe decreased five percent to $10.39 per boe. Operating expenses were lower due to increased processing revenues received on third party production, decreased electrical power rates and lower well maintenance and liquids transportation expenditures.

Masters expects 2008 operating expenses per boe to be similar to 2007.



Netback Analysis
($ per boe) 2007 2006
----------------------------------------------------------------------------
Oil and natural gas revenues 46.23 45.53
Royalty and other revenue 1.44 1.68
--------------------------
47.67 47.21
Royalty expense, net of ARTC (9.66) (8.55)
Operating expenses (10.39) (10.89)
--------------------------
Operating netback 27.62 27.77
--------------------------
--------------------------


GENERAL AND ADMINISTRATIVE
---------------------------

($ thousands, except as indicated) 2007 2006
----------------------------------------------------------------------------
Gross general and administrative 2,734 2,594
Operating recoveries (72) (114)
Capitalized expenses (896) (813)
--------------------------
General and administrative expense,
before stock-based compensation 1,766 1,667
--------------------------
Stock-based compensation 341 533
Capitalized stock-based compensation (187) (211)
--------------------------
Net stock-based compensation expense 154 322
--------------------------
Total general and administrative expense 1,920 1,989
--------------------------
--------------------------
General and administrative expense,
before stock-based compensation, per boe ($) 3.15 3.24
--------------------------
--------------------------
Total general and administrative expense per
boe ($) 3.42 3.87
--------------------------
--------------------------


On a per boe basis, total general and administrative expense in 2007 decreased 12 percent to $3.42 per boe (2006 - $3.87 per boe). The five percent increase in gross general and administrative expenses 2007 to $2.7 million (2006 - $2.6 million), resulted mainly from increased professional fees and full year salaries of 2006 staff additions. During 2007, Masters capitalized approximately one-third of general and administrative costs associated with exploration and development activities. Masters capitalizes general and administrative expense directly related to exploration and development activities as these costs are associated with adding reserves. General and administrative expenses for 2007 include a non-cash provision of $0.2 million (2006 - $0.3 million) for stock-based compensation.

We anticipate that total general and administrative expenses for 2008 will be similar to 2007. Based on forecasted production and capital spending, we estimate 2008 staff levels will be similar to 2007. As we bring new production on-stream, we anticipate a reduction in general and administrative costs per boe.



INTEREST EXPENSE
-----------------

($ thousands except as indicated) 2007 2006
----------------------------------------------------------------------------
Total interest expense 1,226 1,014
--------------------------
--------------------------
Per boe ($) 2.18 1.97
--------------------------
--------------------------


Interest expense increased 21 percent to $1.2 million in 2007 (2006 - $1.0 million). This reflects an increase in average debt levels during the year as interest rates remained relatively stable. At year end 2007, Masters had bank debt of $18.2 million (2006 - $17.8 million). Average debt outstanding during the year was approximately $19.8 million (2006 - $17.6 million). Increased exploration and development activities during the first half of 2007 led to an increase in the year end balance from the average annual borrowing level. Our average interest rate to borrow during the year was 6.15 percent (2006 - 5.75 percent).

Masters forecasts average bank debt and interest rates for 2008 will be approximately the same as 2007. For 2008, we anticipate that Masters' ratio of net debt to funds generated by operations will be approximately in the range of 1.2 - 1.5 to one.



DEPLETION, DEPRECIATION AND ACCRETION
--------------------------------------

($ thousands except as indicated) 2007 2006
----------------------------------------------------------------------------
Depletion 10,473 9,260
Depreciation 8 10
Accretion on asset retirement obligations 124 130
--------------------------
Total depletion, depreciation and accretion
expense 10,605 9,400
--------------------------
--------------------------
Depletion, depreciation and accretion
expense per boe ($) 18.87 18.29
--------------------------
--------------------------


During 2007, depletion, depreciation and accretion expense increased 13 percent to $10.6 million (2006 - $9.4 million). This increase is the result of Masters' higher production and increased cost for reserve additions. Depletion, depreciation and accretion increased three percent to $18.87 per boe during 2007 (2006 - $18.29 per boe) as a result of 2007 finding and development costs being slightly higher than the historical carrying values of assets eligible for depletion.

Masters performs an annual ceiling test in accordance with the Canadian Institute Chartered Accountants' full cost accounting guidelines, using forecasted prices determined by the independent qualified reserves evaluator who evaluates Masters' reserves. At December 31, 2007, the impairment recognition portion of the ceiling test indicated that the estimated undiscounted future cash flows from proved reserves exceeded the carrying values of producing petroleum and natural gas properties and, therefore, a ceiling test adjustment was not required.



INCOME TAXES
-------------

($ thousands, except as indicated) 2007 2006
----------------------------------------------------------------------------
Future income tax (reduction) expense (57) 334
--------------------------
--------------------------
Effective income tax rate (%) - 18.0
--------------------------
--------------------------


Future income tax (reduction) expense decreased 124 percent in 2007 to $(0.1) million (2006 - $0.3 million). The decrease in 2007 future tax expense is due to lower earnings before income taxes and a reduction in the federal and provincial income tax rates that were substantially enacted during 2007. Based on available tax pools, forecasted capital spending levels and commodity prices, Masters does not expect to be currently taxable for the 2008 year.

Masters has approximately $48.1 million in tax pools to shelter taxable income in the future years.

The table below shows estimated 2007 tax pools.



($thousands) 2007
----------------------------------------------------------------------------
Canadian exploration expense 8,873
Canadian Development Expense 7,982
Canadian Oil and Gas Property Expense 14,701
Undepreciated Capital Cost 16,152
Other 412
--------------------------
Total 48,120
--------------------------
--------------------------


NET EARNINGS and FUNDS GENERATED BY OPERATING ACTIVITIES

In 2007, net earnings decreased 18 percent to $1.5 million (2006 - $1.9 million), primarily from increased depletion, depreciation and accretion expense. Net earnings decreased in 2007 to $2.67 per boe (2006 - $3.61 per boe) while funds generated by operating activities decreased in 2007 to $22.29 per boe (2006 - $22.56 per boe).



Net Earnings and Funds Generated By Operating Activities per boe

($/boe) 2007 2006
--------------------------
Total revenues 47.67 47.21
Royalties (9.66) (8.55)
Operating expenses (10.39) (10.89)
--------------------------
Net operating income 27.62 27.77
General and administrative (excluding
stock-based compensation expense) (3.15) (3.24)
Interest expense (2.18) (1.97)
--------------------------
Funds generated by operating activities 22.29 22.56
Depletion, depreciation and accretion (18.87) (18.29)
Stock-based compensation (0.27) (0.63)
Income taxes and other (0.48) (0.03)
--------------------------
Net earnings 2.67 3.61
--------------------------
--------------------------


SHARE CAPITAL

Masters issued no common shares in 2007. In 2006, 1,046,666 common shares were issued on a flow-through basis and on the employees exercise of stock options. Stock options and special warrants granted to employees during the year amounted to 65,000 common shares (2006 - 469,000 common shares).

On November 7, 2006, Masters commenced a normal course issuer bid which was in effect for one year. During this period, Masters acquired and cancelled 173,000 common shares at an average purchase price of $2.78 per share. On November 7, 2007, the normal course issuer bid was renewed for one year. For the period since the commencement of renewed issuer bid until December 31, 2007, Masters acquired and cancelled 41,100 common shares at an average purchase price of $2.22 per shares.

The weighted average common shares outstanding, for the three month period ended December 31, 2007 was 15,389,796 basic (15,449,822 diluted). For the year ended December 31, 2007 the basic weighted average shares outstanding was 15,448,462 (2006 - 15,255,640) and the diluted average shares outstanding was 15,624,618 (2006 - 15,887,870). Common shares issued and outstanding, as at December 31, 2007, were 15,355,879 (2006 - 15,539,979).

As of the date of this MD&A and since the 2007 year-end, an additional 64,700 common shares have been acquired, at an average price of $2.58 per share, and cancelled through the normal course issuer bid.



2007 2006
--------------------------
Outstanding Common Shares (thousands)
Weighted average outstanding common shares
- Basic 15,448 15,256
- Diluted 15,625 15,888
Outstanding common shares at December 31
- Issued and outstanding (basic) 15,356 15,540
- Common share options granted 1,510 1,451
- Common share performance warrants granted 885 885
- Common shares outstanding (diluted) 17,751 17,876

($ thousands except as indicated)
Per Share Information
Net earnings 1,500 1,858
Net earnings per share ($)
- Basic 0.10 0.12
- Diluted 0.10 0.12
Funds from operating activities 12,527 11,537
Funds from operating activities per share ($)
- Basic 0.81 0.75
- Diluted 0.80 0.72
Total asset book value 71,171 70,275
Total asset book value per share(1) ($)
- Basic 4.63 4.52
- Diluted 4.01 3.93
Book value (shareholders' equity) (1) 39,501 39,921
Book value per share ($)
- Basic 2.57 2.57
- Diluted 2.23 2.23
Proved plus probable reserves (mboe) 8,280 4,790
Reserves per 100 shares (boe) (1)
- Basic 53.9 30.8
- Diluted 46.6 26.8
Annual production (mboe) 562 514
Production per 100 shares (boe) (1)
- Basic 3.7 3.3
- Diluted 3.2 2.9

(1) Calculated using outstanding common shares, options and warrants at
year-end.


Net Asset Value

Masters' net asset value per share at December 31, 2007 increased 62 percent to $7.19 (2006 - $4.44) per basic share and by 55 percent to $6.65 (2006 - $4.28) per diluted share.



($ thousands, except as indicated) 2007 2007 2006
----------------------------------------------------------------------------
Constant Forecast Forecast
Price Price(1) Price(1)
Proved plus probable reserves value
(10% discount before tax) 110,452 122,821 76,736
Undeveloped acreage (2) 8,384 8,384 12,233
Net debt (20,788) (20,788) (19,980)
-------------------------------------
Basic net asset value 98,048 110,417 68,989
Projected proceeds on exercise
of options and warrants 7,625 7,625 7,470
-------------------------------------
Diluted net asset value 105,673 118,042 76,459
-------------------------------------
-------------------------------------
Common shares outstanding (thousands)
- Basic 15,356 15,356 15,540
- Diluted 17,751 17,751 17,876
Net asset value per common share ($)
- Basic (3) 6.38 7.19 4.44
- Diluted (3) 5.95 6.65 4.28

(1) The reserves values are based on before tax future cash flows as
evaluated by the Company's independent qualified reserves evaluators,
McDaniel using their future commodity price forecast, then in effect.
(2) The land values are determined internally using an estimated value in
2007 of $100 (2006 - $150) per undeveloped acre.
(3) Calculated using outstanding common shares, options and warrants at
year-end.


Share Trading Activity

Masters common shares are listed and posted for trading on the TSX under the symbol MSY. The following table summarizes monthly trading activity of Masters common shares for the year ended December 31, 2007.



Month Volume High Low Close
----------------------------------------------------------------------------

January 457,000 3.40 2.96 3.20
February 534,300 3.20 2.53 2.53
March 1,345,300 2.89 2.41 2.89
April 567,600 3.20 2.72 2.95
May 292,000 3.00 2.81 3.00
June 395,200 3.22 2.90 3.08
July 162,400 3.14 2.70 2.73
August 353,200 2.81 2.27 2.33
September 180,500 2.45 2.08 2.18
October 526,000 2.59 2.03 2.36
November 685,700 2.65 2.01 2.10
December 376,600 2.45 2.05 2.33

Year ended December 31, 2006

Month Volume High Low Close
----------------------------------------------------------------------------
January 705,000 6.75 4.86 5.79
February 497,900 5.61 4.25 4.72
March 554,300 5.15 4.25 4.89
April 286,000 5.39 4.46 5.00
May 305,900 5.04 3.75 4.15
June 212,500 4.40 3.56 3.80
July 163,400 3.81 3.25 3.75
August 154,600 4.28 3.75 3.76
September 455,000 4.25 3.26 3.35
October 262,200 4.08 3.00 4.00
November 296,400 4.07 3.28 3.32
December 306,400 3.59 3.17 3.40


CAPITAL EXPENDITURES

Total net capital expenditures during 2007, after the disposal of oil and natural gas property interests for proceeds of $0.3 million, were $12.2 million (2006 - $18.3 million). The 2007 exploration and development activity resulted in 19 (2006 - 31) gross exploration and development wells drilled, acquisition of 29,975 (2006 - 11,683) net acres of undeveloped crown land, completion of several 3D seismic programs to acquire seven (2006 - 150) square kilometers of data and over 120 (2006 - 100) kilometers of 2D seismic data. In 2007, Masters' exploration and development capital allocation was approximately $7.2 (2006 - $6.3) million in southern Alberta and $5.0 (2006 - $18.2) million in northern and central Alberta.



($ thousands) 2007 2006
--------- ---------
Land 1,926 1,669
Geological and geophysical 1,055 3,305
Drilling and completions 5,145 11,892
Equipping and facilities 3,499 7,623
--------- ---------

Total exploration and development capital 11,625 24,489
Producing property acquisitions 882 -
Disposal of property (265) (6,200)
--------- ---------
Total capital expenditures 12,242 18,289
--------- ---------
--------- ---------


Land Holdings

During 2007, Masters' undeveloped land increased by two percent to 84,000 net acres. The increase is due to a combination of undeveloped lands acquired during the year exceeding expiries and undeveloped land converted to developed land as a result of drilling wells. In 2007 Masters acquired 29,975 net acres (2006 - 11,683 net acres) through crown land sales. The average working interest of the undeveloped lands Masters owned at December 31, 2007 was 52 percent (2006 - 42 percent).

The following table sets out our developed and undeveloped land holdings as at December 31, 2007.



DEVELOPED UNDEVELOPED TOTAL
-------------- --------------- ----------------
Gross Net Gross Net Gross Net
------ ------ ------- ------ ------- -------
(acres)
Alberta - northern 54,719 16,783 134,247 63,222 188,966 80,005

Alberta - southern 23,625 16,135 26,081 20,620 49,706 36,755
------ ------ ------- ------ ------- -------
Total 78,344 32,918 160,328 83,842 238,672 116,760
------ ------ ------- ------ ------- -------
------ ------ ------- ------ ------- -------

The following table sets out our developed and undeveloped land holdings as
at December 31, 2006.

DEVELOPED UNDEVELOPED TOTAL
-------------- --------------- ----------------
Gross Net Gross Net Gross Net
------ ------ ------- ------ ------- -------
(acres)
Alberta - northern 58,399 17,256 170,812 63,373 229,211 80,629

Alberta - southern 26,178 17,825 24,546 18,179 50,724 36,004
------ ------ ------- ------ ------- -------
Total 84,577 35,081 195,358 81,552 279,935 116,633
------ ------ ------- ------ ------- -------
------ ------ ------- ------ ------- -------


Finding and Development Costs

During 2007, our exploration and development program resulted in total proved reserve additions, after prior year revisions, of 203,000 boe, or 3,766,000 boe on a proved plus probable basis. Masters' total finding and development and net acquisition ("FD&A") costs, before the change in future development costs, were $29.50 per proved boe and $3.01 per proved plus probable boe.

After adding in the change in future development capital, FD&A costs were $26.33 per proved boe and $18.10 per proved plus probable boe.

The combined three year average 2005 to 2007 capital programs, including the acquisitions at Little Bow and North Peace River Arch, resulted in FD&A costs of $21.89 per proved boe and $8.14 per proved plus probable boe. After adding in the change to estimated FD&A costs were $21.39 per proved boe and $16.76 per proved plus probable boe. The majority (97 percent) of the future development capital is associated with the capital required for the enhanced oil recovery project at Little Bow.

The reserves disclosed for 2007 and 2006 conform with the requirements of National Instrument 51-101, Standards of Disclosure for Oil and Gas Activities.



2007 Finding & Development (F&D) and Net Acquisition (FD&A) Costs

Proved
plus Proved
Proved Probable plus
Capital Reserves Proved Reserves Probable
Expenditures Additions Costs Additions Costs
----------------------------------------------------------------------------
($ thousands) (mboe) ($/boe) (mboe) ($/boe)
F&D exploration and
development programs
before revisions 11,626 130 89.43 3,885 2.99
----------------------------------------------------------------------------
----------------------------------------------------------------------------
F&D exploration and
development program
after revisions (a) 11,626 203 57.27 3,766 3.09
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Change in proved future
development capital (b) (1,317) n/a n/a n/a n/a
----------------------------------------------------------------------------
Change in proved plus
probable future
development capital (c) 61,390 n/a n/a n/a n/a
----------------------------------------------------------------------------
Proved F&D including
change in future
development capital
(d) equals (a+b) 10,309 203 50.78 n/a n/a
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Proved plus probable
F&D including change in
future development capital
(e) equals (a+c) 73,016 n/a n/a 3,766 19.39
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net acquisition/
(disposition)
activity reserves(f) 617 212 2.89 302 2.04
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2007 FD&A costs
before future
development costs (a+f) 12,242 415 29.50 4,068 3.01
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2007 proved FD&A
costs including future
development costs (d+f) 10,926 415 26.33 n/a n/a
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2007 proved plus
probable FD&A costs
including future
development costs (e+f) 73,633 n/a n/a 4,068 18.10
----------------------------------------------------------------------------
----------------------------------------------------------------------------

2006 Finding & Development (F&D) and Net Acquisition (FD&A) Costs

Proved
plus Proved
Proved Probable plus
Capital Reserves Proved Reserves Probable
Expenditures Additions Costs Additions Costs
----------------------------------------------------------------------------
($ thousands) (mboe) ($/boe) (mboe) ($/boe)
F&D exploration and
development programs
before revisions 24,489 758 32.31 1,299 18.85
----------------------------------------------------------------------------
----------------------------------------------------------------------------
F&D exploration and
development program
after revisions (a) 24,489 954 25.67 1,318 18.58
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Change in proved future
development capital (b) 91 n/a n/a n/a n/a
----------------------------------------------------------------------------
Change in proved plus
probable future
development capital (c) 579 n/a n/a n/a n/a
----------------------------------------------------------------------------
Proved F&D including
change in future
development capital
(d) equals (a+b) 24,580 954 25.77 n/a n/a
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Proved plus probable
F&D including change in
future development capital
(e) equals (a+c) 25,068 n/a n/a 1,318 19.02
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net acquisition
activity(f) (6,200) - n/a - n/a
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2006 FD&A costs
before future
development
costs (a+f) 18,289 954 19.17 1,318 13.88
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2006 proved FD&A
costs including future
development costs (d+f) 18,380 954 19.27 n/a n/a
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2006 proved plus
probable FD&A costs
including future
development costs (e+f) 18,868 n/a n/a 1,318 14.32
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Combined 2005 to 2007 Finding & Development (F&D) and Net Acquisition
(FD&A) Costs

The combined three year average 2005 to 2007 results are more representative
of management's efforts as presented in the table below.


Proved
plus Proved
Proved Probable plus
Capital Reserves Proved Reserves Probable
Expenditures Additions Costs Additions Costs
----------------------------------------------------------------------------
($ thousands) (mboe) ($/boe) (mboe) ($/boe)
F&D exploration and
development programs
before revisions 56,404 1,590 35.41 6,126 9.21
----------------------------------------------------------------------------
----------------------------------------------------------------------------
F&D exploration and
development program
after revisions (a) 56,404 2,017 27.96 6,194 9.11
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Change in proved future
development capital (b) (1,317) n/a n/a n/a n/a
----------------------------------------------------------------------------
Change in proved plus
probable future development
capital (c) 61,390 n/a n/a n/a n/a
----------------------------------------------------------------------------
Proved F&D including change
in future development capital
(d) equals (a+b) 5,087 2,017 27.31 n/a n/a
----------------------------------------------------------------------------
Proved plus probable F&D
including change in future
development capital (e)
equals (a+c) 117,794 n/a n/a 6,194 19.02
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Net acquisition/
(disposition)activity(f) 1,661 636 2.61 935 1.78
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2005 to 2007 FD&A
costs before future
development costs (a+f) 58,065 2,653 21.89 7,129 8.14
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2005 to 2007 proved
FD&A costs including future
development costs (d+f) 56,748 2,653 21.39 n/a n/a
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Total 2005 to 2007 proved
plus probable FD&A costs
including future development
costs (e+f) 119,455 n/a n/a 7,129 16.76
----------------------------------------------------------------------------
----------------------------------------------------------------------------

Reserves Replacement

Masters' 2007 capital expenditure program replaced production by a factor
of 0.7 (2006 -- 1.9) times on a proved basis and 7.2 (2006 - 2.6) times on
a proved plus probable basis.

2007 2006
----------------------------------------------------------------------------
Production (mboe) 562 514
Proved reserves additions after revisions (mboe) 415 954
Proved replacement ratio 0.7 1.9
Proved plus probable reserves additions after
revisions (mboe) 4,068 1,318
Proved plus probable replacement ratio 7.2 2.6


Recycle Ratio

Recycle ratio is a measure for evaluating the effectiveness of a company's re-investment in its exploration and development program. The ratio measures the efficiency of capital investment by comparing the operating netback per boe to that year's finding and development and net acquisition costs per boe.



2007 2006
----------------------------------------------------------------------------
Operating netbacks ($/boe) 27.62 27.77
Proved FD&A costs after revisions and including the
change in future development cost ($/boe) 26.33 19.27
Proved reinvestment efficiency ratio 1.0 1.4
Proved plus probable FD&A costs after revisions and
including the change in future development cost ($/boe) 18.10 14.32
Proved plus probable reinvestment efficiency ratio 1.5 1.9


Drilling Results

During 2007, Masters drilled and recompleted 19 (2006 - 31) exploration and development wells resulting in four (2006 - nil) oil wells and six (2006 - 17) natural gas wells for an overall success rate of 53 percent (2006 - 55 percent). Of the total wells drilled and recompleted, 11 (2006 - 27) were in northern and central Alberta and the remaining eight (2006 - 4) were in southern Alberta.



2007 2006
-----------------------------------------
(wells) Gross Net Gross Net
----------------------------------------------------------------------------
Oil 4 4.0 - -
Natural gas 6 3.3 17 7.0
Dry and abandoned 9 6.5 14 7.1
-----------------------------------------
Total 19 13.8 31 14.1
-----------------------------------------
-----------------------------------------
Success rate (%) 53 53 55 50
-----------------------------------------
-----------------------------------------


CONTRACTUAL OBLIGATION

As part of our land acquisition strategy in our core areas, Masters will farm-in or commit to industry partners to drill wells, shoot seismic programs or tie-in previously drilled wells to earn interests in undeveloped land. As at the date of this MD&A, Masters has not committed to drill any farm-in wells.

Masters has firm transportation commitments to deliver minimum natural gas production volumes to an aggregator pipeline. The potential maximum liability is based on the committed delivery and is reduced until the agreed upon production volume amount is achieved.

Masters has contractual obligations on operating leases of field equipment. These operating leases are short term and due within one year, if demanded.



The table below shows payments due within the periods indicated.
Less
than 1 1 - 3 4 - 5 After 5
($ thousands) Total Year Years Years Years
----------------------------------------------------------------------------
Firm transportation commitments 921 257 601 63 -
Operating leases 30 30 - - -
Office lease 244 89 155 - -
---------------------------------------------
Total contractual obligations 1,195 376 756 63 -
---------------------------------------------
---------------------------------------------


LIQUIDITY AND CAPITAL RESOURCES

Total capitalization at December 31, 2007 was $64.6 million (2006 - $78.6 million) with the market value of common shares representing 56 percent of total capitalization. Net debt represented 32 percent and asset retirement obligations plus future income taxes accounted for 12 percent.



Total Market Capitalization
($ thousands except as indicated) 2007 % 2006 %
----------------------------------------------------------------------------
Common shares outstanding (thousands) 15,356 15,540
Closing share price at December 31 ($) 2.33 3.40
---------------------------------
Total market capitalization 35,779 56 52,836 67
---------------------------------
Working capital deficiency 2,560 2,156
Bank debt 18,228 17,824
---------------------------------
Net debt 20,788 32 19,980 25
---------------------------------
Asset retirement obligations 3,957 6 3,527 5
Future income taxes 4,091 6 2,283 3
---------------------------------
Total capitalization 64,615 100 78,626 100
---------------------------------
---------------------------------
Net debt to total capitalization 32% 25%
---------------------------------
---------------------------------


At December 31, 2007 Masters had borrowed approximately $18.2 (2006 - $17.8) million and had a working capital deficit of $2.6 (2006 - $2.2) million amounting to total net debt of $20.8 (2006 - $20.0) million. Net debt for 2007 represents approximately 1.7 (2006 - 1.7) times funds generated by operating activities of $12.5 million (2006 - $11.4 million) and approximately 1.2 to 1.5 times budgeted 2008 funds generated by operating activities.

Masters has a bank revolving term facility of $28 million to fund future activities. 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 facility is reviewed semi-annually in April and October. As at December 31, 2007, Masters had drawn $18.2 million of the revolving term facility.

The capital intensive nature of our activities can create a negative working capital position in quarters with high levels of exploration and development capital spending.

The industry has a pre-arranged monthly settlement day for payment of revenues from all buyers of crude and natural gas. This occurs on the 25(th) day following the month in which the production is sold. As a result Masters collects sales revenues in an organized manner. Management monitors purchaser credit positions to mitigate any potential credit losses. To the extent Masters has joint interest activities with industry partners we must collect, on a monthly basis, partners' share of capital and operating expenses. These collections are subject to normal industry risk. Masters collects in advance for significant amounts related to partners' share of capital expenditures in accordance with the industry operating procedures. At December 31, 2007 Masters had no material accounts receivable deemed uncollectible.

Accounts payable consists of invoices payable to trade suppliers relating to office and field operating activities and our capital spending program. Masters processes invoices within a normal payment period.

We continually manage Masters' capital spending program by monitoring forecasted production, commodity prices and anticipated cash flow. Should circumstances arise that negatively affect cash flow, Masters is capable of reducing the level of future capital spending.

We will fund our future investing activities, which consist primarily of capital expenditures on oil and natural gas activities, with working capital, cash flow from operations, a limited amount of bank debt and, possibly, from the issuance of new equity.



Debt Ratios
($ thousands, except as indicated) 2007 2006
----------------------------------------------------------------------------
Working capital deficiency 2,560 2,156
Bank debt 18,228 17,824
--------------------------
Net debt 20,788 19,980
--------------------------
--------------------------
Debt to funds generated by operating
activities ratio
Funds generated by operating activities 12,527 11,537
Trailing net debt 20,788 19,980
Years of funds flow from operating activities
to repay trailing net debt
- Current year funds generated by
operating activities 1.7 1.7
- Estimated forward funds generated by
operating activities 1.2 - 1.5 1.1
Asset coverage ratio
Total assets 71,171 70,275
Net debt 20,788 19,980
Asset coverage 3.42 3.52
Debt/equity ratio
Net debt 20,788 19,980
Shareholders' equity 39,501 39,921
Debt/equity 0.53 0.50


OUTLOOK

The acquisitions of the North Peace River Arch and Little Bow properties established a strong production base from which Masters can grow. With an experienced technical team, a large undeveloped land base (84,000 net acres) and a number of internally-generated prospects, we expect to continue to grow. We believe Masters can deliver production averaging 1,600 - 1,800 boe/d in 2008 from internally-generated exploration and development. The Board of Directors has approved a $15.5 million capital program that will focus on exploiting existing internal opportunities and on continuing to build an inventory of exploration and development opportunities expected to provide growth through 2008 and beyond. We anticipate capital expenditures to be approximately equal to funds generated by operations.

In addition to our ongoing exploration and development program, Masters will seek growth through acquisitions that are strategic and have the potential to add future shareholder value.

2008 Capital Budget

Masters' 2007 capital program expanded our core areas in southern and northern Alberta by adding prospective lands and a large seismic data base. Through the efforts of this program we established a large inventory of future drilling opportunities. In 2008 we expect to drill approximately 20-25 wells in our current areas of focus.

Masters anticipates 2008 funds generated by operating activities will reach approximately $13-$15 million. This is based on forecasted 2008 average production of 1,600-1,800 boe/d, average commodity prices of $76.00 per bbl for Edmonton light quality crude oil (US$75.00 per barrel WTI) and $5.90 per GJ ($6.25 per mcf) for natural gas at the wellhead, foreign exchange of US$0.97 and costs remaining at historical levels.

We are forecasting our 2008 capital program at $15.5 million with an approximate allocation of $2.5 million for land and seismic, $8.0 million for drilling and completions, and $5.0 million for equipment and facilities. The majority of the capital program will be funded through funds generated by operations. We forecast net debt of $20.8 million at December 31, 2007 will increase modestly to approximately $20 - $22 million at 2008 year-end.

Masters will continue to exploit our Little Bow property with the implementation of a tertiary recovery flood. Further detailed engineering design and reservoir simulation studies will be carried out before construction of the ASP facility begins at Little Bow. Total cost of the project, including the cost of the facilities, field infrastructure and injection chemicals, are expected to be refined by the end of the first quarter 2008. An application to implement the enhanced oil recovery project is expected to be submitted to the ERCB subsequent to completing the engineering work.

2008 Sensitivities

Based on the forecast assumption of 1,700 boe per day, Masters provides the following sensitivities to indicate the potential impact on funds generated by operating activities in the event of changes in commodity prices, the foreign currency exchange rate and average daily production volumes.



Funds Generated by Per Share -
($ thousands, except as indicated) Operating Activities Basic ($)
----------------------------------------------------------------------------
Impact on 2008:
Change in WTI oil price of US$5.00
per bbl 1,300 0.08
Change in natural gas price of Cdn$1.00
per mcf 1,600 0.10
Change in US dollar to Cdn dollar of
US$0.01 200 0.01
Change in 100 bbl per day of liquids
production 1,100 0.07
Change in 1,000 mcf per day of natural
gas production 1,300 0.08


SELECTED QUARTERLY INFORMATION (unaudited)

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 2006
--------------------------------------------------------
Operations Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
--------------------------------------------------------
Production
Oil (bbl/d) 754 787 768 734 749 791 781 813
NGL (bbl/d) 13 13 16 8 10 10 13 9
Natural gas
(mcf/d) 4,711 4,698 4,758 4,216 4,417 2,897 3,543 3,888
Total (boe/d) 1,552 1,583 1,576 1,445 1,495 1,284 1,384 1,470
Pricing
Oil ($/bbl) 55.49 54.41 49.08 47.78 42.31 58.03 59.65 39.82
NGL ($/bbl) 84.34 63.02 60.02 55.43 71.65 62.71 61.62 56.87
Natural gas
($/mcf) 6.39 6.07 7.27 7.28 7.07 5.61 5.91 7.41
Total ($/boe) 47.04 45.57 46.44 45.83 42.57 48.92 49.34 41.97
Financial
($ thousands, except
as indicated)
Total revenue 6,966 6,823 6,889 6,108 5,960 5,971 6,545 5,788
Funds from
operating
activities 3,384 3,309 3,129 2,705 2,234 3,198 3,542 2,563
Net earnings (loss) 774 267 553 (94) 26 815 800 217
Per share - basic 0.05 0.02 0.04 (0.01) 0.00 0.05 0.05 0.02
Per share -
diluted 0.05 0.02 0.04 (0.01) 0.00 0.05 0.05 0.01
Capital
spending
Exploration and
development 2,131 2,863 2,998 3,634 6,022 5,625 4,487 8,355
Acquisitions/
(dispositions) - - 617 - - (6,200) - -
Total assets 71,171 70,440 70,361 69,586 70,275 65,176 66,533 64,228
Working capital
deficiency 2,560 1,342 1,062 1,990 2,156 1,904 1,496 7,477
Long-term debt 18,228 20,300 20,741 19,550 17,824 14,467 18,584 17,442
Shareholders'
equity 39,501 38,805 38,552 37,910 39,921 39,861 38,940 32,064
Common Shares
Weighted average
common shares
outstanding
(thousands)
- basic 15,390 15,449 15,460 15,506 15,559 15,570 15,356 14,523
- diluted 15,450 15,586 15,745 15,717 15,974 16,093 16,052 15,433
Trading
Activity
Volume
(thousands)
- total 1,588 696 1,255 2,337 865 773 804 1,757
- daily 25 11 20 37 14 12 13 27
Price ($ per
share)
- high 2.65 3.14 3.22 3.40 4.08 4.28 5.39 6.75
- low 2.01 2.08 2.72 2.41 3.00 3.25 3.56 4.25
- closing 2.33 2.18 3.08 2.89 3.40 3.35 3.80 4.89



Factors that caused variations over the quarters

- Masters completed four significant 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 plus probable
reserves acquired were approximately 1.4 million boe with an estimated
reserves 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 plus probable reserves
acquired were approximately 1.1 million boe with an estimated reserves
life index of 7.9 years based on production at the time of acquisition.
- The two acquisitions of producing properties in the North Peace River
Arch area of northwest Alberta on June 3, 2006 and September 12, 2006
added approximately 160 boe per day consisting primarily of natural gas
production. Proved plus probable reserves acquired were approximately
0.5 million boe with an estimated reserves 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 cash flow is the combination of increased production and strong commodity prices. Generally, commodity prices were consistently strong throughout 2006 and 2007.

- Depletion, depreciation, accretion and future income taxes influence net earnings. Masters estimates reserves internally every quarter based on acquisition and drilling activities. Independent qualified reserves evaluators determine annual reserves, the results of which can affect fourth quarter reserves additions. Enacted changes to 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 operating activities, bank debt and the issuance of common shares primarily funded capital spending.



FOURTH QUARTER ANALYSIS (unaudited)

% %
Change Change
Q4 2007 Q4 2007
vs vs
Q4 2007 Q3 2007 Q4 2006 Q3 2007 Q4 2006
------------------------------------------------
Operations Results
-------------------
Production
Crude oil (bbls/d) 754 787 749 (4) 1
NGL (bbls/d) 13 13 10 - 30
Natural gas (mcf/d) 4,711 4,698 4,417 - 7
Total (boe/d) 1,552 1,583 1,495 (2) 4
Pricing
Crude oil ($/bbl) 55.49 54.41 42.31 2 31
NGL ($/bbl) 84.34 63.02 71.65 34 18
Natural gas ($/mcf) 6.39 6.07 7.07 5 (10)
Selected Financial Results
---------------------------
($ thousands except as
indicated)
Total revenue 6,966 6,823 5,960 2 17
Royalties (1,433) (1,421) (1,147) 1 25
Operating expense (1,355) (1,543) (1,842) (14) (28)
General and administrative (510) (268) (549) 90 (7)
Funds generated by operating
activities 3,384 3,309 2,234 2 51
Depletion, depreciation and
accretion 2,745 2,776 2,503 1 10
Net earnings 774 267 26 190 2,877
per share -basic ($) 0.05 0.02 0.00 150 500
per share - diluted ($) 0.05 0.02 0.00 150 500
Capital spending
exploration and development 2,131 2,863 6,022 (26) (65)
acquisitions/(dispositions) - - - - -
Total capital spending 2,131 2,863 6,022 (26) (65)
Working capital deficiency 2,560 1,342 2,156 91 19
Long-term debt 18,228 20,300 17,824 (10) 2
Shareholders' equity 39,501 38,805 39,921 2 (1)
Weighted average common
shares outstanding (thousands)
- basic 15,390 15,449 15,559 - (1)
- diluted 15,450 15,586 15,974 (1) (3)


PRODUCTION

Production for the fourth quarter 2007 decreased two percent to 1,552 boe/d compared to the 2007 third quarter at 1,583 boe/d and increased four percent compared to the 2006 fourth quarter. The production decrease in the 2007 fourth quarter occurred as a result of Little Bow being temporarily suspended during the first week of October 2007 due to repairs at a downstream third party facility. During the month of December 2007 production averaged 1,638 boe/d. Production increases since the 2006 fourth quarter are due to placing successful wells drilled on-stream.

REVENUES

Revenues for the 2007 fourth quarter increased two percent to $7.0 million compared to the 2007 third quarter and increased 17 percent from the 2006 fourth quarter. In the quarter ended December 31, 2007, Edmonton Par postings for crude oil were comparable to the third quarter. Natural gas spot prices increased five percent in the fourth quarter 2007 compared to the third quarter 2007, but were down 10 percent compared with the 2006 fourth quarter.

ROYALTIES

Royalties for the 2007 fourth quarter of $1.4 million were comparable to the 2007 third quarter and increased 27 percent from the 2006 fourth quarter. The majority of royalty expense incurred during the quarters was payable to the Crown. Royalties for the period ended December 31, 2007 increased from the same period in 2006 as a result of higher oil and natural gas revenues. We anticipate the future average royalty rates to be modestly higher with increased commodity prices and the expiration of royalty holidays on eligible producing wells.

OPERATING EXPENSES

Operating expenses for the 2007 fourth quarter decreased 12 percent to $1.4 million from $1.5 million in the 2007 third quarter. Equalization throughput adjustments on jointly owned facilities decreased the operating costs in the quarter. For the three months ended December 31, 2007 operating expenses decreased 28 percent from the same period in 2006 as result of the previously noted exceptions and higher than normal utility fees and third party processing fees during the fourth quarter of 2006. Masters forecasts operating costs will average approximately $10.40 per boe during 2008.

GENERAL AND ADMINISTRATIVE

The 2007 fourth quarter general and administrative expense increased 90 percent to $0.5 million from the 2007 third quarter and decreased seven percent from the 2006 fourth quarter. General and administrative expenses averaged $3.57 per boe for the 2007 fourth quarter compared to $1.84 per boe in the 2007 third quarter and $3.99 per boe in the 2006 fourth quarter. The 2007 fourth quarter general and administrative expenses include provisions for the annual audit and reserves reports ($175,000). Masters forecasts 2008 general and administrative expenses at approximately $3.00 per boe.

DEPLETION, DEPRECIATION AND ACCRETION

Depletion, depreciation and accretion expense for the 2007 fourth quarter was $2.7 million compared to $2.8 million for the 2007 third quarter and $2.5 million for the 2006 fourth quarter. Depletion, depreciation and accretion provision for the 2007 fourth quarter was $19.23 per boe compared to $19.07 per boe in the 2007 third quarter and $18.19 per boe for the 2006 fourth quarter. The depletion rate per boe for the 2007 fourth quarter reflected the adjustment of proved reserves to the year-end reserves evaluation report.

INCOME TAXES

The future income tax reduction for the 2007 fourth quarter was $0.3 million compared to $0.1 million expense for the 2007 third quarter and $0.1 million reduction for the 2006 fourth quarter. The increase for the fourth quarter 2007 reduction of income taxes is due to a reduction of federal and provincial income tax rates that were substantially enacted during the period.

NET EARNINGS

Net earnings for the 2007 fourth quarter were $0.8 compared to $0.3 million for the 2007 third quarter and $nil million during the 2006 fourth quarter. The increase in net earnings recorded in the 2007 fourth quarter compared to 2007 third quarter is mainly due to lower future taxes. For the three months ended December 31, 2007, the increase in net earnings compared to the 2006 fourth quarter is due to higher revenues and lower operating expenses.

CAPITAL EXPENDITURES

During the 2007 fourth quarter, Masters spent $2.1 million on exploration and development capital including $0.2 million in land, $0.1 million in seismic, $0.8 million in drilling and completions and $1.0 million in facilities. During the quarter ended December 31, 2007, the Company drilled and abandoned two wells, acquired 2,944 net acres of undeveloped land; and installed natural gas facilities to bring a natural gas well on-stream at Enchant.

Capital spending during the 2007 fourth quarter was $2.1 million compared to $2.9 million in the 2007 third quarter and to $6.0 million in the 2006 fourth quarter

CRITICAL ACCOUNTING ESTIMATES

1. Depletion and Depreciation Expense of Petroleum and Natural Gas Properties

Masters follows the full cost method of accounting by initially capitalizing all costs related to exploration for, and the development of, petroleum and natural gas reserves. Costs capitalized include land acquisition costs, geological and geophysical expenditures, rentals on undeveloped properties, costs of drilling productive and non-productive wells, together with overhead directly related to exploration and development activities and lease and well equipment. Costs capitalized are depleted and depreciated using the unit-of-production method based upon gross proved petroleum and natural gas reserves as determined by independent qualified reserves evaluators. Production and reserves of petroleum and natural gas are converted to common units of measure based on their relative energy content, where one barrel of oil is equivalent to six thousand cubic feet of natural gas.

The depletion and depreciation base excludes the cost of significant unproved properties until it is determined whether proved reserves are attributable to the properties, or impairment has occurred.

Masters performs a ceiling test, whereby, if the carrying value of the oil and natural gas properties less accumulated depletion and depreciation, related asset retirement obligations and the lesser of cost and fair value of unproven properties exceeds the estimated future cash flows from the proved and probable oil and natural gas reserves, discounted at the company's credit-adjusted risk-free rate of interest, using forecast prices and costs. Any impairment recognized is recorded as additional depletion and depreciation expense.

Estimates are the basis for amounts recorded for depletion and depreciation of oil and natural gas properties, and the ceiling test. These estimates include proved and probable reserves, production rates, future petroleum and natural gas prices, future costs and other relevant assumptions.

By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates could be material in future periods.

2. Asset Retirement Obligations

Masters recognizes the liability for asset retirement obligations associated with the abandonment of oil and natural gas wells, related facilities, compressors and plants, removal of equipment from leased acreage and returning such land to its original condition. The fair value of each asset retirement obligation is recorded in the period a well or related asset is drilled, constructed or acquired. Fair value is estimated using the present value of the estimated future cash outflows to abandon the asset at the company's credit-adjusted risk-free interest rate. Future costs are estimates that are subject to measurement uncertainty and any change would impact the liability.

3. Stock-based Compensation

The amounts disclosed relating to the fair value of stock options and performance warrants issued and the resulting income effect are based on estimates of the future volatility of Masters' share price, expected lives of the options, expected dividends and other relevant assumptions. By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates could be material in future periods.

4. Income Taxes

The determination of the company's income and other tax liabilities requires interpretation of complex laws and regulations often involving multiple jurisdictions. All tax filings are subject to audit and potential reassessment after the lapse of considerable time. Accordingly, the actual income tax liability and expense may differ from that estimated and recorded.

CHANGES IN ACCOUNTING PRINCIPLES

Masters adopted the following changes in accounting principles in 2007:

1. Financial Instruments

Commencing January 1, 2007, the following CICA standards regarding financial instruments are in effect;

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 required 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 are measured at their amortized cost. The standards created a statement of comprehensive income that includes changes in fair value of certain derivative financial instruments. The Company elects to mark-to-market its derivative contracts under its risk management program.

RECENT ACCOUNTING PRONOUNCEMENTS

Management is assessing the following new and revised accounting pronouncements that have been issued and are not yet effective:

1. International Financial Reporting Standards ("IFRS")

Over the next five years the CICA will adopt its new strategic plan for the direction of accounting standards in Canada ratified in 2006. As part of that plan, accounting standards in Canada for public companies will converge with IFRS over the period. On February 13, 2008, Canada's Accounting Standard Board confirmed January 1, 2011 as the effective date for complete convergence of Canadian GAAP to IFRS. The Canadian Securities Administrators are in the process of examining changes to securities rules as a result this initiative. Masters will continue to monitor and assess the impact of the planned convergence of Canadian GAAP with IFRS.

2. Financial Instruments - Disclosures

CICA handbook sections 3862 and 3863 applies to both recognized and unrecognized financial instruments. Commencing January 1, 2008, disclosure will include the discussion of the nature and the extent of risks arising from financial instruments.

3. Capital Disclosures

Commencing January 1, 2008, the CICA handbook section 1535 requires that Masters disclose the Company's objectives, policies and processes for managing the capital structure.

DISCLOSURE CONTROLS and PROCEDURES

Disclosure controls and procedures are designed to ensure that information Masters is required to be disclosed is accumulated and communicated to management, as appropriate, to allow timely disclosure. The Chief Executive Officer and Chief Financial Officer evaluated Masters' disclosure controls and procedures as of December 31, 2007 and concluded that Masters' design of the disclosure controls and procedures were appropriate to ensure that information the Company is required to disclose in its annual and interim filings or other reports (as defined in National Instrument 52-109 of the Canadian Securities Administrators) filed or submitted under provincial legislation is recorded, processed, summarized and reported within the time periods specified in the provincial securities legislation and to ensure that information required to be disclosed by Masters is accumulated and communicated to company management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

The evaluation took into consideration Masters' Disclosure Policy and the functioning of its executive officers, board of directors and board committees. In addition, the evaluation covered the company's processes, systems and capabilities relating to regulatory filings, public disclosures and the identification and communication of material information. All controls and procedures, no matter how well designed, have inherent limitations. These disclosure controls and procedures provide reasonable, but not absolute, assurance that financial information is accurate and complete.

INTERNAL CONTROLS OVER FINANCIAL REPORTING

The Chief Executive Officer and Chief Financial Officer of the Company are responsible for designing internal controls over financial reporting or causing them to be designed under their supervision in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Canadian GAAP. Through the design of controls certain weaknesses have been identified. The inherit weaknesses are the result of the Company size and the limited number staff and include:

i. the inability to achieve complete segregation of duties; and

ii. not having sufficient financial staff with the required technical knowledge to deal with complex and non-routine accounting matters.

The Company believes these weaknesses are mitigated by:

i. the Chief Executive Officer and Chief Financial Officer overseeing all material transactions;

ii. the audit committee, comprised of independent members of the Board of Directors, reviewing the quarterly interims and annual audited financial statements with management;

iii. the Board of Directors approval of the financial statements based on the audit committee's recommendation after its review; and

iv. the Company consulting with its third party expert advisors as needed in connection with the recording and reporting of complex and non-routine transactions.

These mitigating factors will not necessarily prevent the likelihood that a material misstatement will not occur as a result of the aforesaid weaknesses in the Company's internal controls over financial reporting. A system of internal controls over financial reporting, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the internal controls over financial reporting are met. The officers' Certification of Annual Filings is filed and available on SEDAR at www.sedar.com.

BUSINESS RISKS and UNCERTAINTIES

There are a number of risks facing participants in the Canadian oil and gas industry. Some of the risks are common to all businesses while others are specific to the sector.

Masters is engaged in the exploration, development, production and acquisition of crude oil and natural gas. Masters' business has inherent risk and there is no assurance that Masters will discover or economically produce hydrocarbon reserves. Financial risks associated with the petroleum industry include market fluctuations in commodity prices, interest rates, changes in government legislation and currency exchange rates. Operational risks include industry competition, environmental factors, reservoir performance uncertainties, a complex regulatory environment and safety concerns.

The exploration for and production of crude oil and natural gas requires manpower and capital. Masters employs highly qualified experienced staff who have demonstrated the ability to generate quality drilling prospects utilizing the latest technological tools to increase the probability of success. The probability of drilling a successful well is enhanced when the company explores in core areas that have multi-zone potential, focusing on low-to-moderate risk prospects with a limited exposure to high-risk, high-reward opportunities. Masters maintains operational control in a majority of its prospects, which enables management to control the timing, assignment of resources and capital invested in exploration and development opportunities.

A wide number of factors beyond Masters' control influence commodity prices. To manage this risk, we concentrate in regions which permit multiple delivery points to markets and enter into fixed price commodity contracts, on a limited portion of production, within the Company's self imposed hedging guideline.

The acquisition of undeveloped mineral leases, supply of services and production equipment at competitive prices is essential to the ability to add reserves at a competitive cost and to produce these reserves in an economic and timely fashion. In periods of increased activity, these services and supplies can become difficult and expensive to obtain. Increased prices for supplies and services can inflate costs of operations and potentially erode product netbacks. Masters attempts to mitigate this risk by developing strong long-term relationships with industry participants, suppliers and contractors.

There are potential risks to the environment inherent to Masters' business activities. To mitigate these risks, Masters conducts high standards of operations and follows safety procedures designed to protect and maintain the environment and public and employee safety, with respect to all corporate operations on behalf of shareholders, staff and stakeholders at large. Masters minimizes environmental and safety risks by maintaining its facilities, complying with all provincial and federal environmental and safety regulations and carrying adequate insurance coverage.



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

Assets

Current assets
Accounts receivable $ 2,517 $ 4,283
Prepaid expenses and deposits 317 281
----------- --------

2,834 4,564

Property and equipment (note 2) 68,337 65,711
----------- --------

$ 71,171 $ 70,275
----------- --------
----------- --------

Liabilities

Current liabilities
Accounts payable and accrued liabilities $ 5,394 $ 6,720

Long-term bank debt (note 3) 18,228 17,824

Asset retirement obligations (note 4) 3,957 3,527

Future income taxes (note 8) 4,091 2,283
----------- --------

31,670 30,354
----------- --------
Shareholders' Equity

Share capital (note 5) 31,111 33,314
Contributed surplus (note 6) 1,103 820
Retained earnings 7,287 5,787
----------- --------
39,501 39,921
----------- --------

Commitments (note 9)

Subsequent events (notes 5 and 11)
$ 71,171 $ 70,275
----------- --------
----------- --------

See accompanying notes to the financial statements.


Masters Energy Inc.
Statements of Earnings, Comprehensive Income and Retained Earnings
For the years ended December 31, 2007 and 2006
----------------------------------------------------------------------------
($ thousands except share and per share amounts)
2007 2006
Revenue
Petroleum and natural gas revenue $ 25,976 $ 23,405
Royalty and other revenue 810 859
------------ -------------
26,786 24,264
Royalties, net of Alberta Royalty Tax Credit (5,426) (4,394)
------------ -------------
21,360 19,870
Unrealized (loss) gain on commodity contract (325) 325
------------ -------------
21,035 20,195
------------ -------------
Expenses
Operating 5,841 5,600
General and administrative 1,920 1,989
Interest 1,226 1,014
Depletion, depreciation and accretion 10,605 9,400
------------ -------------

19,592 18,003
------------ -------------

Earnings before income taxes 1,443 2,192
Future income tax (reduction) expense (note 8) (57) 334
------------ -------------

Net earnings and comprehensive income 1,500 1,858

Retained earnings, beginning of year 5,787 3,929
------------ -------------

Retained earnings, end of year $ 7,287 $ 5,787
------------ -------------
------------ -------------

Earnings per share (note 7)
Basic $ 0.10 $ 0.12
Diluted $ 0.10 $ 0.12

Weighted average number of shares outstanding
(note 7)
Basic 15,448,462 15,255,640
------------ -------------
------------ -------------
Diluted 15,624,618 15,887,870
------------ -------------
------------ -------------

See accompanying notes to the financial statements.


Masters Energy Inc.
Statements of Cash Flows
For the years ended December 31, 2007 and 2006
----------------------------------------------------------------------------
($ thousands)
Cash provided by (used for):
2007 2006
Operating activities
Net earnings $ 1,500 $ 1,858
Add (deduct) non-cash items
Depletion, depreciation and accretion 10,605 9,400
Future tax (reduction) expense (57) 334
Stock-based compensation expense 154 322
Unrealized loss (gain) on commodity contract 325 (325)
Settlement of performance warrants - (52)
Settlement of asset retirement costs (note 4) (298) (98)
Changes in non-cash working capital 275 (1,865)
---------- --------

12,504 9,574
---------- --------

Financing activities
Increase in long-term bank debt 404 3,731
Proceeds on share issuance - 6,100
Proceeds on exercise of options and warrants - 99
Purchase of shares for cancellation (470) (102)
Share issuance costs - (446)
---------- --------

(66) 9,382
---------- --------

Investing activities
Petroleum and natural gas properties

Exploration and development (11,625) (24,489)
Producing property acquisitions (882) -
Disposal of property 265 6,200
---------- --------

(12,242) (18,289)
Changes in non-cash working capital (196) (667)
---------- --------

(12,438) (18,956)
Change in cash and cash equivalents - -

Cash and cash equivalents, beginning of year - -
---------- --------

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

Supplemental Cash Flow Information
-----------------------------------
Interest income received $ 5 $ 1
Interest paid $ 1,226 $ 1,014
Capital taxes paid $ - $ 3
----------------------------------------------------------------------------
See accompanying notes to the financial statements.


Masters Energy Inc.
Notes to the Financial Statements
For the years ended December 31, 2007 and 2006
----------------------------------------------------------------------------
(Tabular amounts in $ thousands except share and per share amounts)


Description of business

Masters Energy Inc. ("Masters" or the "Company") is engaged in the exploration, development and production of petroleum and natural gas in western Canada.

1. Significant accounting policies

(a) Basis of presentation

The financial statements are stated in Canadian dollars and have been prepared in accordance with Canadian generally accepted accounting principles.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.

(b) Cash and cash equivalents

Cash and cash equivalents consisted of amounts on deposit with banks and term deposits with original maturities of less than 90 days.

(c) Property and equipment

The Company follows the full cost method for accounting for petroleum and natural gas operations whereby all costs related to the exploration for and the development of petroleum and natural gas reserves are capitalized. Costs capitalized include land acquisition costs, geological and geophysical expenditures, rentals on undeveloped properties, costs of drilling productive and non-productive wells, together with overhead directly related to exploration and development activities and production and well equipment.

Costs capitalized together with future capital costs are depleted and depreciated using the unit-of-production method based upon gross proved petroleum and natural gas reserves as determined by independent qualified reserves evaluators at future prices and costs. Production and reserves of petroleum and natural gas are converted to common units of measure based on their relative energy content, where one barrel of oil is equivalent to six thousand cubic feet of natural gas.

The cost of significant unproved properties is excluded from the depletion and depreciation base until it is determined whether proved reserves are attributable to the properties, or impairment has occurred.

The Company performs a ceiling test for impairment for each cost centre in a two-stage test undertaken at least annually.

(i) Impairment is recognized if the carrying value of the petroleum and natural gas properties, less accumulated depletion and depreciation, exceeds the estimated future cash flows from proved oil and natural gas reserves, on an undiscounted basis, using forecast prices and costs and the lower of cost and fair value of unproven properties. Future cash flows are calculated before interest, general and administrative expenses and income taxes.

(ii) If impairment is indicated by applying the calculations described in (i) above, the Company will measure the amount of the impairment by comparing the carrying value of the petroleum and natural gas properties less accumulated depletion and depreciation to the estimated future cash flows from the proved and probable oil and natural gas reserves, discounted at a risk-free rate of interest, using forecast prices and costs and the lower of cost and fair value of unproven properties. Any impairment recognized is recorded as additional depletion and depreciation expense.

Gains or losses are not recognized upon disposition of petroleum and natural gas properties unless such a disposition would alter the rate of depletion and depreciation by 20 percent or more.

The costs of office equipment are amortized at rates approximating their useful lives on a declining balance basis of 30 percent per year.

(d) Joint operations

Substantially all of the Company's exploration and production activities are conducted jointly with others and, accordingly, these financial statements reflect only the Company's interest in such activities.

(e) Asset retirement obligations

The Company recognizes the liability for retirement obligations associated with the abandonment of petroleum and natural gas wells, related facilities, compressors and plants, removal of equipment from leased acreage and returning such land to its original condition. The fair value of each asset retirement obligation is recorded in the period a well or related asset is drilled, constructed or acquired. Fair value is estimated using the present value of the estimated future cash outflows to abandon the asset at the Company's credit-adjusted risk-free interest rate. The obligation is reviewed regularly by Company management based on current regulations, costs, technologies and industry standards. The discounted obligation is initially capitalized as part of the carrying amount of the related oil and natural gas properties, and a corresponding liability is recognized. This component of the increase in petroleum and natural gas properties is depleted and depreciated on the same basis as the remainder of the petroleum and natural gas properties. The liability is adjusted for accretion charged to income until the obligation is settled or sold and for revisions to the estimated cash flows. Actual costs incurred upon settlement of the obligations are charged against the liability.

(f) Flow-through shares

From time to time, the Company issues flow-through shares to finance a portion of its capital expenditure program. Pursuant to the terms of the flow-through share agreements, the tax deductions associated with the expenditures are renounced to the subscribers. Accordingly, share capital is reduced and a future income tax liability is recorded equal to the estimated amount of future income taxes payable by the Company as a result of the renunciations, when the expenditures are renounced.

(g) Stock-based compensation

The Company issues stock options and performance warrants to directors, officers and employees as described in note 6. Compensation cost, attributable to stock options and performance warrants granted, is measured by the fair value method of accounting at the date of grant and expensed over the vesting period with a corresponding increase in contributed surplus. When stock options or performance warrants are exercised, the cash proceeds, together with the amount previously recorded as contributed surplus are recorded as share capital. The Company incorporates an estimated forfeiture rate of ten percent for stock options and performance warrants that will not vest.

(h) Revenue recognition and operating expenses

Revenue from the sale of oil and natural gas is recognized based on volumes delivered to customers at contractual delivery points and rates. The costs associated with the delivery, including operating and maintenance costs, transportation and production-based royalty expenses are recognized in the same period in which the related revenue is earned and recorded.

(i) Income taxes

Future income taxes are accounted for using the liability method of income tax allocation. Under the liability method, estimated future tax assets and liabilities are determined based upon differences between the carrying amount as reported on the balance sheet and the tax basis of assets and liabilities. Future income tax assets and liabilities are determined based on the income tax laws and rates that are anticipated to apply in the period of reversal. A valuation allowance is recognized against any future income tax assets if it is considered more likely than not that the asset will not be realized.

(j) Per share amounts

Basic per share amounts are calculated using the weighted average number of common shares outstanding during the year. The Company utilizes the treasury stock method for the calculation of diluted per share amounts. This method assumes that the proceeds from the exercise of in-the-money stock options and warrants plus the unamortized stock-based compensation are used to repurchase Company shares at the weighted average market price during the period.

(k) Measurement uncertainty

The amounts recorded for depletion and depreciation of oil and gas properties, the asset retirement obligation and the ceiling test are based on estimates. These estimates include proved and probable reserves, production rates, future petroleum and natural gas prices, future costs and other relevant assumptions.

The amounts disclosed relating to the fair value of stock options and performance warrants issued and the resulting income effect are based on estimates of the future volatility of the Company's share price, expected lives of the options, expected dividends and other relevant assumptions.

By their nature, these estimates are subject to measurement uncertainty and the effect on the financial statements of changes in such estimates in future periods could be material.

(l) 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. All financial instruments, including all derivatives, are required 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 instrument is derecognized or impaired at which time the amounts would be recorded in net earnings. The Company classified its cash as held-for-trading, accounts receivable are classified as loans and accounts payable and long-term debt are classified as other financial liabilities.

Derivative financial instruments are used by Masters to manage economic exposure to market risks relating to commodity prices. The Company's policy is not to utilize derivative financial instruments for speculative purposes. The Company elects not to use hedge accounting for its natural gas derivative contract under its risk management program. Financial contracts are recorded following the fair value method whereby instruments are recorded in the balance sheet as either as asset or liability with changes in fair value recognized in net earnings. Realized gains or losses from financial derivatives related to commodity prices are recognized in natural gas and crude revenues as related sales occur. Unrealized gains or losses are recognized in revenues at the end of each respective reporting period. The estimated fair value of derivative instruments is based on quoted forward price curves.

The Company elects 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.

A new statement of comprehensive income is required, 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 year ended December 31, 2007 and no opening or closing balances for the accumulated other comprehensive income or loss.

New accounting standards have been issued that will require additional disclosure in the Company's financial statements as well as its capital resources and how they are managed.



2. Property and equipment

Accumulated
Depletion
and Net Book
As at December 31, 2007 Cost Depreciation Value
------------------------ ----------- -------------- ------------
------------------------ ----------- -------------- ------------

Petroleum and natural gas
properties and well equipment $ 98,863 $ 30,553 $ 68,310
Office equipment 73 46 27
----------- -------------- ------------

$ 98,164 $ 30,599 $ 68,337
----------- -------------- ------------
----------- -------------- ------------

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 $7.6 million at December 31, 2007 (December 31, 2006 - $7.6 million).

As at December 31, 2007, $1.1 million (December 31, 2006 - $1.0 million) of general and administrative costs were capitalized.

The benchmark and Company prices on which the December 31, 2007 ceiling test for impairment is based, are as follows.



Oil Natural Gas Natural Gas Liquids
--------------------- -------------------- ---------------------
Bow River AECO
Medium Spot Edmonton
Benchmark Company Benchmark Company enchmark Company
($/bbl) ($/bbl) ($/GJ) ($/mcf) ($/bbl) ($/bbl)

2008 64.70 63.89 6.45 6.75 61.60 69.63
2009 62.30 61.88 7.00 7.42 60.20 69.79
2010 59.70 58.69 7.00 7.55 58.00 72.83
2011 57.00 55.54 7.00 7.52 55.80 68.39
2012 56.20 54.40 7.10 7.63 55.20 66.12
2013 55.30 53.44 7.30 8.12 54.70 62.06


Prices increase at a rate of approximately 2.0 percent per year for oil, natural gas and natural gas liquids after 2013. Adjustments were made to the benchmark prices, for purposes of the ceiling test, to reflect varied delivery points and quality differentials in the products delivered.

3. Long-term 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 December 31, 2007, $18.2 million (December 31, 2006 - $17.8 million) has been drawn against the revolving term 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 obligations for the years ended December 31, as indicated.



2007 2006
--------- ---------
--------- ---------
Asset retirement obligations, beginning of year $ 3,527 $ 3,316
Adjustments 481 (122)
Liabilities acquired 151 -
Liabilities disposed (92) -
Liabilities incurred 64 301
Settlement of asset retirement costs (298) (98)
Accretion expense 124 130
--------- ---------

Asset retirement obligations, end of year $ 3,957 $ 3,527
--------- ---------
--------- ---------


The total estimated, undiscounted cash flows required to settle the obligations as at December 31, 2007, before considering salvage, is $4.8 million (2006 -- $4.9 million) 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 one 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

Number Amount
------------ -----------

Common Shares, December 31, 2005 14,523,313 $ 27,469

Issue of flow-through shares 1,000,000 6,100

Exercise of stock options 46,666 99

Shares repurchased and cancelled (30,000) (67)

Share issue costs (net of future tax
benefit of $140,000) (306)

Transfer from contributed surplus for
exercise of options and warrants 19
------------ -----------

Common Shares, December 31, 2006 15,539,979 33,314

Shares repurchased and cancelled (184,100) (412)

Future income tax effect of flow-through
share issue (1,791)

Common Shares, December 31, 2007 15,355,879 $ 31,111
------------ -----------
------------ -----------


(c) 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 was obligated to incur $6.1 million of qualifying expenditures prior to December 31, 2007. As at December 31, 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) 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 terminated on November 6, 2007.

In November 2007, the Company renewed the normal course issuer bid to purchase and cancel up to 1,100,000 common shares. The issuer bid will terminate on November 6, 2008.

During 2007, the Company purchased 184,100 common shares (2006 - 30,000 common shares) for total consideration of $470,000 (2006 - $102,000). Of the amount paid, $412,000 (2006 - $67,000) was charged to share capital and $58,000 (2006 - $35,000) was charged to contributed surplus.

Subsequent to the 2007 year-end, the Company has purchased 64,700 common shares under the issuer bid for total consideration of $167,000.

6. Stock - based compensation plans

The Company's stock-based compensation plans are described below:

(a) Stock options

The Company's stock option plan allows for options to be granted to employees, officers, directors and other service providers. The number of shares which may be issued, and that have been reserved, under the plan is limited to 10 percent of the issued and outstanding common shares. The maximum number of shares that may be reserved for issuance to any one person under the plan is limited to five percent per year of the issued and outstanding Common Shares and Special Warrants for employees, officers and directors and two percent for other service providers. The plan also provides that the price at which options may be granted cannot be less than the volume weighted average trading price of the common shares for the five trading days prior to the date of grant. Options granted under the plan have a maximum life of five years and vest at an equal amount over three years on the anniversary date of the grant or as determined by the Board of Directors.

The following tables summarize information about the Company's stock options outstanding at December 31, 2007.



Weighted
Average
Number of Exercise
Options Price ($)
----------- ----------

Balance, December 31, 2005 1,127,000 2.28
Granted 404,000 4.62
Forfeited (33,334) 2.09
Exercised (46,666) 2.12
-----------

Balance, December 31, 2006 1,451,000 2.94
Granted 65,000 2.80
Forfeited (6,000) 4.58
-----------

Balance, December 31, 2007 1,510,000 2.93
-----------
-----------


As of December 31, 2007, 1,162,999 stock options (2006 - 814,665) have
vested at an average exercise price of $2.54 per option (2006 - $2.21) .

Weighted
Average
Options Years to
Exercise Price per Share ($) Outstanding Expiry
---------------------------- ------------- ----------
2.00 400,000 1.0
2.35 572,000 1.3
2.60 25,000 2.0
2.80 65,000 4.3
3.80 50,000 2.5
4.70 150,000 3.3
4.58 248,000 3.4
----------------------------------------------------------------------------

Weighted average 2.93 1,510,000 1.8
----------------------------------------------------------------------------
----------------------------------------------------------------------------


The Company has recorded stock-based compensation expense of $0.2 million as at December 31, 2007, (2006 - $0.3 million) for options and warrants vested during the period. Using the Black-Scholes model, assuming the expected life of the options and warrants are five years and no expected future dividends, the following table summarizes the total fair value of options and warrants granted.



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

May 11, 2006 319,000 44 4.0 577

April 10, 2006 150,000 42 3.7 266

July 26, 2005 50,000 46 3.8 78

December 23, 2004 25,000 33 3.4 21

April 26, 2004 655,000 26 3.4 455


(b) Performance warrants

The Company's Performance Warrants Plan allows for Performance Warrants to be granted to employees, officers and directors. The maximum number of shares which may be issued, and that have been reserved, under the plan is 1,000,000 common shares. Performance Warrants granted under the plan have a five year life, vest immediately and have no performance criteria other than the escalating exercise price. As at December 31, 2007, 885,000 (2006 -- 885,000) Performance Warrants have been granted, expiring December 22, 2008, with the following exercise prices.



Weighted
Performance Average
Warrants Exercise
Outstanding and Price per
Exercisable Warrant ($)
----------------- ------------

Balance, December 31, 2005 870,000 3.55

Granted 65,000 4.58

Settled (50,000) 3.66
-----------------

Balance, December 31, 2006 and 2007 885,000 3.62
-----------------
-----------------


(c) Contributed surplus

The following table reconciles the Company's contributed surplus for the years ended December 31, as indicated.



2007 2006
----------- -----------
Balance, beginning of year $ 820 $ 393
Stock-based compensation expense 154 322
Capitalized stock-based compensation 187 211
Exercise of options and performance warrants - (19)
Settlement of performance warrants - (52)
Reacquisition and cancellation of common shares (58) (35)
----------- -----------
Balance, end of year $ 1,103 $ 820
----------- -----------
----------- -----------


7. Per share amounts

Earnings per share has been calculated using the basic weighted average number of common shares outstanding of 15,448,462 (2006 -- 15,255,640) during the year ended December 31, 2007. As at December 31, 2007, a total of 176,156 (2006 -- 632,230) were added to the total to take into account the dilutive effect of the options for the year.

8. 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 percent (2006 -- 34.5 percent) to income before income taxes. The difference results from the following:



2007 2006
----------- -----------
Expected income tax expense $ 463 $ 756

Increase (decrease) resulting from:
Non-deductible crown payments - 469
Resource allowance - (402)
Effect of change in enacted income tax rates (571) (461)
Stock based compensation expense 49 111
Other 2 (139)
----------- -----------
Future income tax (reduction) expense $ (57) $ 334
----------- -----------
----------- -----------


(b) The components of the future income tax liability at December 31 are as
follows:

2007 2006
----------- -----------
Carrying value of property and equipment in
excess of available tax deductions $ 5,034 $ 3,546
Asset retirement obligation (835) (1,036)
Share issuance costs (108) (227)
----------- -----------
$ 4,091 $ 2,283
----------- -----------
----------- -----------


As at December 31, 2007, the Company has income tax deductions of approximately $48.1 million (2006 -- $49.0 million) available for deduction against future taxable income.



9. Commitments

The table below shows commitments due within the periods indicated.

Less
than 1 1 - 3 4 - 5 After 5
Total Year Years Years Years
----------------------------------------------------------------------------
Firm transportation commitments 921 257 601 63 -
Operating leases 30 30 - - -
Office lease 244 89 155 - -
--------------------------------------
Total contractual obligations 1,195 376 756 63 -
--------------------------------------
--------------------------------------


10. Financial instruments

(a) Fair values

The fair values of the Company's accounts receivable, accounts payable and accrued liabilities approximate their carrying values due to their short-term maturity. The Company's long-term debt bears interest at a floating market rate and accordingly the fair market value approximates the carrying value.

(b) Credit risk

The Company's credit risk is limited to the carrying amount of its accounts receivable, which are due primarily from other entities involved in the oil and gas industry. These amounts are subject to the same risks as the industry as a whole.

(c) Interest rate risk

The Company is exposed to interest rate risk to the extent the changes in market interest rates will impact the Company's debts that have a floating interest rate.

11. Subsequent Event

(b) 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 and future contracts are subject to market risk from fluctuating commodity prices and exchange rates; however, gains or losses on the contracts are offset by changes in the value of the Company's production and recognized in income in the same period and category as the hedged item.

The Company uses derivative instruments to reduce its exposure to fluctuations in commodity prices. Subsequent to December 31, 2007, the following derivative contract was put in place:



Daily Notional
Product Index Term Volume Price Received
----------------------------------------------------------------------------
Gas Fixed AECO-C Apr. 1/08 - Oct. 31/08 2,500 GJ $7.745 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".

Additional information regarding Masters may be viewed on the SEDAR website (www.sedar.com) or the Company's website (www.mastersenergy.com).

ADVISORIES

The calculations of barrels of oil equivalent ("boe") are based on a conversion rate of six thousand cubic feet ("mcf") of natural gas to one barrel ("bbl") of crude oil. Boe's may be misleading, particularly if used in isolation. A boe conversion ratio of 6 mcf : 1 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.

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 commodity prices, currency fluctuations, uncertainties 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 contained herein or to update the reasons why actual results could differ from those contemplated by the forward-looking statements, unless so required by applicable securities law.

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